Assume that UPS is considering implementing certain transactions to hedge against potential fluctuations in gas and fuel costs and in exchange rates. It is estimated that such transactions would reduce UPS’s cash flow volatility and, thus, decrease the firm’s market beta from 0.99 to 0.70.

Required

????????????Estimate UPS’s cost of equity capital and its weighted average cost of capital assuming it enters into the hedges.

????????????Assume that the market’s expected growth in UPS dividends is 4.20%, and that the cost of the hedge transactions would reduce UPS’s projected dividend growth by 0.20%. Using the Gordon growth DDM, infer the stock value per share.

D12-46. Estimating Cost of Debt Capital The December 31, 2015, partial financial statements taken from the annual report for AT&T Inc.
follow.
Consolidated Statements of Income Dollars in millions 2015 2014 Operating revenues Service . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $131,677 $118,437 Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,124 14,010 Total operating revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146,801 132,447 Operating expenses Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,268 18,946 Broadcast, programming and operations. . . . . . . . . . . . . . . . . . . . . . . . . . 11,996 4,075 Other cost of services (exclusive of depreciation and amortization shown separately below) . . . . . . . . . . . . . . . . . . . . . . . . . . 35,782 37,124 Selling, general and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,954 39,697 Abandonment of network assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 2,120 Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,016 18,273 Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122,016 120,235 Operating income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,785 12,212 Other income (expense)
Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,120) (3,613)
Equity in net income of affiliates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 175 Other income (expense) - net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (52) 1,581 Total other income (expense) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,093) (1,857)
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,692 10,355 Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,005 3,619 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,687 $ 6,736 Consolidated Balance Sheets—Liabilities and Equity Sections Dollars in millions except per share amounts, December 31 2015 2014 Current liabilities Debt maturing within one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,636 6,056 Accounts payable and accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . 30,372 23,592 Advanced billings and customer deposits . . . . . . . . . . . . . . . . . . . . . . . . . . 4,682 4,105 Accrued taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,176 1,091 Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,950 2,438 Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,816 37,282 Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118,515 75,778 Deferred credits and other noncurrent liabilities Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56,181 38,436 Postemployment benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34,262 37,079 Other noncurrent liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,258 17,989 Total deferred credits and other noncurrent liabilities . . . . . . . . . . . . . . . . . 112,701 93,504

???????????????? ????????????????
Stockholders’ equity Common stock ($1 par value, 14,000,000,000 authorized at December 31, 2015 and 2014:
issued 6,495,231,088 at December 31, 2015 and 2014) . . . . . . . . . . . . . 6,4956,495 Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89,76391,108 Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,671 31,081 Treasury stock (350,291,239 at December 31, 2015 and 1,308,318,131 at December 31, 2014, at cost) . . . . . . . . . . . . . . . . . . . . (12,592) (47,029)
Accumulated other comprehensive income. . . . . . . . . . . . . . . . . . . . . . . . . 5,334 8,061 Noncontrolling interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 969 554 Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123,640 90,270 Total liabilities and stockholders' equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . $402,672 $296,834 Consolidated Statements of Stockholders’ Equity—Excerpts Dollars and shares in millions except per share amounts 2015 Shares Amount Common stock Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,495 $ 6,495 Issuance of stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — —
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,495 $ 6,495 Additional paid-in capital Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 91,108 Issuance of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,597)
Share-based payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252 Change related to acquisition of interests held by noncontrolling owners . . —
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 89,763 Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 31,081 Net income attributable to AT&T ($2.37, $1.24 and $3.42 per diluted share) . . . . . . . . . . . . . . . . . . . . . . . . . 13,345 Dividends to stockholders ($1.89, $1.85 and $1.81 per share) . . . . . . . . . . . (10,755)
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 33,671 Treasury stock Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,308) $(47,029)
Repurchase of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8) (278)
Issuance of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 966 34,715 Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (350) $(12,592)
Required

a. How much interest expense did AT&T incur during 2015?

b. What is the book value of AT&T’s interest-bearing debt at the end of 2015? At the beginning of 2015?

c. Estimate AT&T’s 2015 pretax cost of debt capital.

d. Estimate AT&T’s 2015 effective (that is, average) tax rate from information in its income statement.

e. Estimate AT&T’s 2015 after-tax cost of debt capital. The company’s assumed statutory tax rate is 37%. Which tax rate, the statutory rate or the effective rate, is appropriate for computing its cost of debt capital?
D12-47. Estimating Cost of Equity Capital and Weighted Average Cost of Capital Refer to the information regarding AT&T Inc. in D12-46. In mid 2016, finance.yahoo.com reports that AT&T has a market beta of 0.34, and that its closing stock price at the end of 2015 was $34.41.

Required

a. Explain what AT&T’s market beta of 0.34 implies regarding its stock price volatility.

b. Assume that the market risk premium equals 5% and that the risk-free rate equals 2.5%. Estimate AT&T’s cost of equity capital using the CAPM model.

c. Footnote 10 of AT&T’s 10-K reports that the market value of its debt is approximately $131.701 billion. Assume that the company’s after-tax cost of debt is 2.49%. Using this information, estimate AT&T’s weighted average cost of capital.