Question

Cargill's Cost of Capital. Cargill is generally considered to be the largest privately held company in the world. Headquartered in​ Minneapolis, Minnesota, the company has been averaging sales of over ​$115 billion per year over the past​ five-year period. Although the company does not have publicly traded​ shares, it is still extremely important for it to calculate its weighted average cost of capital properly in order to make rational decisions on new investment proposals. Assuming a​ risk-free rate of 4.50%, an effective tax rate of 39%, and a market risk premium of 5.00%, estimate the weighted average cost of capital first for Companies A and​ B, and then make a​ "guesstimate" of what you believe a comparable WACC would be for Cargill. As shown in the popup​ window,

Company A Company B Cargill

Company sales $10 billion $45 billion $115 billion

Company's beta 0.80 0.66 0.91

Credit rating AA A AA

Weighted average cost of debt 6.870% 7.145% 6.845%

Debt to total capital 33% 45% 26%

International sales/Sales 11% 34% 54%,

if we take the approach that the beta for Cargill has to pick up all the incremental​ information, the beta would then fall between say 0.80 and 1.00. If the higher degree of international sales was interpreted as increasing​ risk, beta would be on the higher​ end; yet being a commodity firm in the current​ market, its beta would rarely surpass 1.0.​ Thus, an estimate of 0.91 beta for Cargill sounds reasonable.

1.Using the​ CAPM, what is company​ A's WACC? % ​(Round to two decimal​ places.)

2.Using the​ CAPM, what is company​ B's WACC? % ​(Round to two decimal​ places.)

3. Using the​ CAPM, what is​ Cargill's WACC? % ​(Round to two decimal​ places.)

Answer 1

cost of equity
A	cost of equity	risk free rate+(market risk premium)*beta	4.5+(5)*.8	8.5
B	cost of equity	risk free rate+(market risk premium)*beta	4.5+(5)*.66	7.8
Cargills	cost of equity	risk free rate+(market risk premium)*beta	4.5+(5)*.91	9.05
after tax cost of debt
A	before tax cost of debt*(1-tax rate)	6.87*(1-.39)	4.1907
B	before tax cost of debt*(1-tax rate)	7.145*(1-.39)	4.35845
Cargills	before tax cost of debt*(1-tax rate)	6.845*(1-.39)	4.17545
WACC- A
	source	weight	cost	weight*cost
	debt	0.33	4.1907	1.382931
	equity	0.67	8.5	5.695
	WACC = sum of weight*cost			7.08
WACC- B
	source	weight	cost	weight*cost
	debt	0.45	4.35845	1.961303
	equity	0.55	7.8	4.29
	WACC = sum of weight*cost			6.25
WACC- Cargill's
	source	weight	cost	weight*cost
	debt	0.26	4.17545	1.085617
	equity	0.74	9.05	6.697
	WACC = sum of weight*cost			7.78