Cost of Capital for Master Tools You have recently been hired by Master Tools (MT) in its relatively new treasury manage

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Cost of Capital for Master ToolsYou have recently been hired by Master Tools (MT) in its relativelynew treasury management department. MT was founded eight years agoby Martha Masters. Martha found a method to streamline themanufacturing process, resulting in a cheaper tool. The toolsmanufactured by MT are designed for the mass market and soldprimarily through retail. The company is privately owned by Marthaand her family, and it had sales of $97 million last year.
MT primarily sells to do-it-yourself (DIY) customers withpersonal projects, although it does sell through various onlinemarketplaces. As a result, the company’s sales are price sensitive.When the company had sufficient capital, it would expandproduction. Relatively little formal analysis has been used in itscapital budgeting process. Martha has just read about capitalbudgeting techniques and has come to you for help. For starters,the company has never attempted to determine its cost of capital,and Martha would like you to perform the analysis. Because thecompany is privately owned, it is difficult to determine the costof equity for the company. Martha wants you to use the pure playapproach to estimate the cost of capital for MT, and she has chosenSnap-On Tools as a representative company. The following questionswill lead you through the steps to calculate this estimate.
Most publicly traded corporations are required to submitquarterly (10-Q) and annual (10-K) reports to the SEC detailing thefinancial operations of the company over the past quarter or year,respectively. These corporate filings are available on the SECwebsite at www.sec.gov. Go to the SEC website, follow the “SearchCompany and Individual Filings” link, and search for SEC filingsmade by Snap-On Tools (SNA). Find the most recent 10-Q or 10-K, anddownload the form. Look at the balance sheet to find the book valueof debt and the book value of equity.
To estimate the cost of equity for SNA, go to finance.yahoo.comand enter the ticker symbol SNA. Follow the links to answer thefollowing questions: What is the most recent stock price listed forSNA? What is the market value of equity, or market capitalization?How many shares of stock does SNA have outstanding? What is theforward annual dividend? Analysts have estimated a six percentgrowth rate for dividends. What is the cost of equity for SNA usingthe DDM? What is the beta for SNA? Now go back to finance.yahoo.comand follow the “Bonds'' link. What is the yield on three-monthTreasury bills? Using the historical market risk premium, what isthe cost of equity for SNA using CAPM? What is your final estimatefor the cost of equity?
You now need to calculate the cost of debt for SNA. Go tofinra-markets.morningstar.com, enter SNA as the company, and findthe yield to maturity for each of SNA’s bonds. What is the weightedaverage cost of debt for SNA using the book value weights and usingthe market value weights? Does it make a difference in this case ifyou use book value weights or market value weights?
You now have all the necessary information to calculate theweighted average cost of capital for SNA. Calculate the WACC usingbook value weights and market value weights. SNA has a 21 percenttax rate. Which number is more relevant?
You used SNA as a pure play company to estimate the cost ofcapital for MT. Are there any potential problems with this approachin this situation?