4-12 Three-Step Process for Estimating a Firms WACC Harriston Electronics builds circuit boards for a variety of applications in industrial equipment. The firm was founded in 1986 by two electrical engineers who left their jobs with General Electric (GE) Corporation. Harriston Electronics balance sheet for year-end 2014 describes a firm with $1,184,841,000 in assets (book values) and invested capital of approximately $2.2 billion (based on market values):

	December 31, 2014
Liabilities and Owners Capital	Balance Sheet (Book Values)	Invested Capital (Market Values)
Current liabilities
?Accounts payable	$ ??17,550,000
?Notes payable	???20,000,000	???20,000,000
?Other current liabilities	? ?22,266,000
??Total current liabilities	$? 59,816,000	$ ? 20,000,000
Long-term debt (7.5% interest paid semiannually, due in 2020)	$? 650,000,000	$ ?624,385,826
??Total liabilities	$? 709,816,000	$ ?644,385,826
Owners capital
?Common stock ($1 par value per share)	$? 20,000,000
?Paid-in-capital	?? 200,025,000
?Accumulated earnings	?? 255,000,000
??Total owners capital	$? 475,025,000	$1,560,000,000
??Total liabilities and owners capital	$1,184,841,000	$2,204,385,826

Harristons CFO, Margaret L. Hines, is concerned that its new investments be required to meet an appropriate cost of capital hurdle before capital is committed. Consequently, she initiated a cost of capital study by one of her senior financial analysts, Jack Frist. Shortly after receiving the assignment, Frist called the firms investment banker to get input on current capital costs.

Frist learned that, although the firms current debt capital required a 7.5% coupon rate of interest (with annual interest payments and no principal repayments until 2020), the current yield to maturity on similar debt had risen to 8.5% so that the current market value of the firms outstanding bonds had fallen to $624,385,826. Because the firms short-term notes were issued within the last thirty days, the 9% contract rate on the notes was the same as the current cost of credit for such notes.

What are Harristons total invested capital and capital structure weights for debt and equity? (Hint: The firm has some short-term debt [notes payable] that, like long-term debt, is also interest-bearing debt.)

Assuming a long-term US Treasury bond yield of 5.42% and an estimated market risk premium of 5%, what is Harristons cost of equity based on CAPM if the firms levered equity beta is 1.2?

What is your estimate of Harristons WACC? The firms tax rate is 35%.

PROBLEM 4-12
Given
	December 31, 2014
Liabilities and Owners' Capital	Balance Sheet (Book Values)	Invested Capital (Market Values)
Current Liabilities
Accounts payable	$17,550,000
Notes payable	20,000,000	20,000,000
Other current liabilities`	22,266,000
Total current liabilities	$59,816,000	$20,000,000
Long-term debt (7.5% interest paid semianually, due in 2012)	$650,000,000	$624,385,826
Total liabilities	$709,816,000	$644,385,826
Owners' Capital
Common stock ($1 par value per share)	$20,000,000
Paid-in-capital	200,025,000
Accumulated earnings	255,000,000
Total owners' capital	$475,025,000	$1,560,000,000
Total liabilities and owners' capital	$1,184,841,000	$2,204,385,826
US Treasury Bond Yield	5.42%
Estimated Market or Equity Risk Premium	5.00%
Current Share Price	$78.00
Market value of owners' equity	??
Current yield on the firm's long-term debt	8.50%
Current yield on the firm's short-term notes	9.00%
Dollar value of short term notes outstanding	$20,000,000
Corporate tax rate	35%
Solution
a. What are Harriston's capital structure weights?
Enterprise value = Market capitalization + Debt		??
Notes payable / Enterprise Value		??
Long-Term Debt / Enterprise Value		??
Equity / Enterprise Value		??
b. What is Harriston's cost of equity capital using the CAPM?
After-Tax Cost of Sources of Capital
Notes Payable (after-taxes)		??
Long-term Debt (after-taxes)		??
Levered equity beta		1.20
Equity (using the CAPM)		??
c. What is Harriston's WACC?
Source of Capital	Capital Structure Weight (Proportion)	After-Tax Cost	Weighted After-Tax Cost
Notes Payable	??	??	??
Long-term Debt	??	??	??
Equity	??	??	??
		WACC	??