The Cost of Capital for Goff Computer, Inc.

The Cost of Capital for Goff Computer, Inc. Rahul Parikh BUS650: Managerial Finance (MAH1209A) Dr Charles Smith March 18, 2012.

Goff Computer, Inc. The Cost of Capital for Goff Computer, Inc.: 1. Most publicly traded corporations are required to submit 10Q (quarterly) and 10K (annual) reports to the SEC detailing their financial operations over the previous quarter or year, respectively. These corporate fillings are available on the SEC Web site at www.sec.gov. Go to the SEC Web site, follow the Search for Company Filings link, the Companies & Other Filers link, enter Dell Computer, and search for SEC filings made by Dell. Find the most recent 10Q and 10K and download the forms. Look on the balance sheet to find the book value of debt and the book value of equity. If you look further down the report, you should find a section titled either Long-term Debt or Long term Debt and Interest Rate Risk Management that will list a breakdown of Dells long-term debt. Answer: The book value of a company's equity is the same as stockholder's equity, which can be computed by subtracting the total value of liabilities from total assets. (Total Assets) = (Total) Liabilities + Stockholder's Equity (book value of equity). Stockholder's Equity (book value of equity) = Total Assets Total Liabilities. The book value of the companys liabilities and equity was found from the site http://www.sec.gov . I found Dells Form 10K, dated January 28, 2011, and snap shot is attached here with. Dells Form 10K shows the following: Book value of equity: 10-k:

Total Assets =38,599 millions; Total Liabilities = 30,833 (Dell 10-K, January 28, 2011, p.57) Book value of equity = Total Assets Total Liabilities = $38,599 $30,833 = $7,766 millions, (Dell 10-K, January 28, 2011, p.57).

Goff Computer, Inc.

The book value of the companys liabilities and equity was found from the site http://www.sec.gov . I found Dells Form 10q, dated October 28, 2011, and snap shot is attached here with. Dells Form 10q showed the following (Note: 10q form also shows data of Dell 10K dated January 28, 2011.]: Book value of equity: 10-Q: Total Assets =42,043 millions; Total Liabilities = 33,380 (Del 10-Q, October 28, 2011) Book value of equity = Total Assets Total Liabilities = $42,043 $33,380 = $8,663 millions, (Dell 10-Q, October 28, 2011).

Goff Computer, Inc.

Book value of debt: It is labeled in the balance sheet as Shareholder's Equity and Liabilities. Book Value of Debt: 10k = $38,599 millions, (Dell 10-K, January 28, 2011, p.57). 10Q = $42,043 millions, (Dell 10-Q, October 28, 2011). Long-term Debt: 10k = $5,146 millions, (Dell 10-K, January 28, 2011, p.57). 10Q = $6,430 millions, (Dell 10-Q, October 28, 2011).

2. To estimate the cost of equity for Dell, go to finance.yahoo.com and enter the ticker symbol Dell. Follow the various links to find answers to the following questions: What is the most recent stock price listed for Dell? What is the market value of equity, or market capitalization? How many shares of stock does Dell have outstanding? What is the beta for Dell? Now go back to finance.yahoo.com and find the bonds link. What is the yield on 3-month Treasury bills? Using a 7 percent market risk premium, what is the cost of equity for Dell using the CAPM?

Answer: To estimate the cost of equity, I collected various pieces of information dated March 4 2012, to calculate the CAPM. The following information, necessary for my

Goff Computer, Inc. calculations, was gathered from finance.yahoo.com. The screen shots below show this information. Most recent stock price is: $17.36 (finance.yahoo.com) Market Capitalization: 30.87B (finance.yahoo.com) Shares Outstanding: 1,918 millions (Dell 10-K, January 28, 2011). Dell Beta: 1.39 (finance.yahoo.com) Yield on 3-month Treasury bills: 0.04 (= 4%); (finance.yahoo.com).

Goff Computer, Inc.

Goff Computer, Inc.

Goff Computer, Inc. Using a 7% market risk premium, what is the cost of equity for Dell using the CAPM? Capital Asset Pricing Model (CAPM) Rs = RF + X (RM RF) Expected return on stock(Rs) = = risk-free rate (RF) + Stock beta () x Market Risk Premium (RM RF) = 4% + (1.39 * 7.0%) = 0.04 + (1.39 * .07) = 0.04 + 0.0973 = 0.1373 = 13.73% Cost of equity for Dell = 13.73%.

3. Calculate the industry average beta. Using the industry average beta, what is the cost of equity? Does it matter if you use the beta for Dell or the beta for the industry in this case?

Industry average beta: Below are the top nine competitors in the computer hardware industry by market capitalization:

Company IBM HPQ Dell CSCO XRX STX AAPL NCR EMC Industrial Average Beta Industry average = 1.42 Cost of equity using industry average beta: Rs = 4%+ (1.42 x 7.0%)

Beta 0.6 1.47 1.39 1.38 1.76 2.8 1.04 1.15 1.17 1.42

Goff Computer, Inc. = 0.04 + (1.42 * .07) = 0.04 + 0.0994 = 0.1394 = 13.94% Cost of equity = 13.94% Does it matter if you use the beta for Dell or the beta for the industry in this case? It would not matter whether we use beta for Dell or beta for the industry, because all companies are not equal to Dell; so there is little difference in the cost of equity. But as Dells beta is very close to average industry beta, I will use the cost of equity using Dells beta.

4. What is the weighted average cost of debt for Dell using the book value weights and the market value weights? Does it make a difference in this case if you use book value weights or market value weights? Bond portfolio: To get the yield to maturity on each of randomly taken four Dells bonds, I went on March 4, 2012, to the site: http://cxa.marketwatch.com/finra/BondCenter/Watchlist.aspx; and following information was obtained, which is the snap shot as below:

Goff Computer, Inc.

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Values from above table, and figures obtained by clicking each bond links were used to calculate the cost of debt for Dell. The weighted average cost of debt for Dell using both the book value and the market value is detailed in following table: Weighted Weighted Percent Yield to Book Market of Maturity values values total(a) (b) (c*b) (a*b) 0.17 0.35 0.28 0.20 1.00 4.723% 0.842% 2.401% 4.583% 0.80% 0.28% 0.67% 1.01% 2.76% 0.80% 0.30% 0.67% 0.92% 2.69%

Book value (millions) Dell GB Dell GF Dell GG Dell GH Total 300 $600 500 400 $1,800

Percent of total (c) 0.17 0.33 0.28 0.22 $1.00

Quoted price 126.580 104.235 118.345 125.005

Market value (millions) 275.016 $566.202 460.530 322.900 $1,624.65

Analyzing above table, it seems that weighted average cost of debt using book value, the weights are 2.76 percent, and using market value, the weights are 2.69 percent. It seems irrelevant whether we use book or market values to calculate the cost of debt for Dell, which

Goff Computer, Inc. means it would not make a difference whether the book or market values were used because they are the approximately the same, and yields almost the same cost of debt.

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5. You now have all the necessary information to calculate the weighted average cost of capital for Dell. Calculate the weighted average cost of capital for Dell using book value weights and market value weights assuming Dell has a 35 percent marginal tax rate. Which cost of capital number is more relevant? Calculation: Using book value weights, the total value of Dell using 10k annual values is: V = $1,800,000,000 + $7,766,000,000 V = $9,566,000,000 So, the WACC based on book value weights using 10k annual values is: WACC = (E/V) x Re + (D/V) x Rd x (1-T) Where: Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt T = corporate tax rate WACC = (0.1373)($ 7.7660/$9.5660) + (.0276)($1.800/$9.5660)(1 .35) = (0.1373)*(.812) + (0.0276) * (.188) * (.65) = (.112) + (.003)

Goff Computer, Inc. WACC = 11.5% Now using the market value weights, the total value of Dell is: V = $1,624,650,000 + $21,728,000,000 V = $23,325,600,000 WACC based on market value weights is: WACC = (E/V) x Re + (D/V) x Rd x (1-T) WACC = (0.1373) * ($21.728/$23.3256) + (.0269) * ($1.62465/$23.3526) *(1 .35) = (.128) + (.001) WACC = 12.9% Conclusion: The cost of capital for Dell using market value weights is higher than book value weights because of higher market-to-book ratio for Dell. The market value is more relevant because it is the actual sale value of the company. 6. You used Dell as a representative company to estimate the cost of capital for GCI. What are some of the potential problems with this approach in this situation? What improvements might you suggest? Answer: Using Dell as a representative company to estimate cost of capital, the leading potential problem with GCI is that it operates stores for companys sales, while Dell sales through its internet site. This could potentially be one of the risk factor affecting the cost of capital. Another factor affecting the cost of capital is that Dell is a fortune 500 company, and is one of the leaders in its industry, so it can access capital being a public company, while GCI is privately owned company. If I had to suggest improvements, I would advice GCI to go as a public sector company, and sale its products on internet, rather than at stores, just like Dell Inc.

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Goff Computer, Inc. References: Apple Inc (AAPL.O), Retrieved March 4, 2012, from http://www.reuters.com/finance/stocks/financialHighlights?symbol=AAPL.O Bond Center. US Treasury Bonds Rates Retrieved March 4, 2012, from http://finance.yahoo.com/bonds Dell Bonds, Market Data; Retrieved March 4, 2012, from http://cxa.marketwatch.com/finra/BondCenter/SearchResult.aspx?q=DELL. Dell Bonds, Watchlist; Retrieved March 4, 2012, from http://cxa.marketwatch.com/finra/BondCenter/Watchlist.aspx Dell Inc. (DELL) Retrieved March 4, 2012, from http://finance.yahoo.com/q?s=Dell&ql=1 Dell Inc.'s 2011 Form 10-K (January 28, 2011), Retrieved March 4, 2012, http://www.sec.gov/Archives/edgar/data/826083/000095012311025579/d78468e10vk .htm Dell Inc.'s 2011 Form 10-Q (October 28, 2011), Retrieved March 4, 2012, from http://www.sec.gov/Archives/edgar/data/826083/000082608311000015/dellq3fy1210 q.htm Hewlett Packard Co (HPQ.N), Retrieved March 4, 2012, from http://www.reuters.com/finance/stocks/financialHighlights?symbol=HPQ.N International Business Machines Corp (IBM.N), Retrieved March 4, 2012, from http://www.reuters.com/finance/stocks/financialHighlights?symbol=IBM.N Ross, S., & Westerfield, R., Jaffe, J., & Jordan, B. (2011), Corporate finance: Core principles and applications (3rd Global ed). Boston, MD: McGraw-Hill Irwin. ISBN: 978-0-07-353068-0.

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