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SelfTestHomework_Topic3_Question.doc.docx - Cost of Capital...

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Cost of Capital and Company Valuation 1. In 2013 Caterpillar Inc. had about 648 million shares outstanding. Their book value was $27 per share, and the market price was $83.50 per share. The company's balance sheet shows that the company had $25.7 billion of long-term debt, which was currently selling near par value. a. What was Caterpillar's book debt-to-value ratio (the ratio of debt to total value)? Book Value= D/V= 25.7/(27x0.648) =0.59 b. What was its market debt-to-value ratio? Market value= D/V= 25.7/(83.50x0.648 )=0.32 c. Which of these two measures should you use to calculate the company's cost of capital? Market value is the proper measure, as it is determined by cash flows and forecasts, rather than accounting rules. 2. Here is a simplified balance sheet for Epicure Pizza (figures in $ millions): Assets Liabilities and Shareholders' Equity Current assets 80 Current liabilities 60 Fixed assets 125 Long-term debt 65 Equity 80 Total 205 Total 205 Note: There are 16 million shares outstanding. Epicure shares are currently priced at $12 each. a. You wish to calculate Epicure's WACC. What is the relevant figure for the company's debt ratio? WACC usually excludes current liabilities, thus the proper debt figure is $65 Million. b. You now realize that since Epicure issued its debt, interest rates have fallen substantially. Do you need to revise your measure of the debt ratio upward or downward? The market value of the debt will increase as interest rates decline thus the firm needs to revise its debt ratio.
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