Book Value of long-term debt $5.366 billion Book value of equity $10.701 billion Market Price $13.48 Shares Outstanding 1.75 billion Market Capitalization $23.59 billion Beta 1.61 3-month Treasury Bill rate 0.01% Industry Beta 1.21

You have recently been hired as the CFO of Apps, Inc. Apps, Inc. was founded seven years ago and is privately owned. Apps Inc. is a software development firm specializing in productivity applications for smartphones, tablets, and personal computers. Apps Inc. has released several public productivity applications; however, the bulk of Apps Inc.'s revenues derive from projects featuring proprietary information. This proprietary information can be either intellectual property of the contracting client or details of the specific application developed by Apps Inc. Apps, Inc. had sales of $97 million last year. The CEO of Apps Inc. has approached you to develop a long-term debt and equity structure to facilitate and accommodate rapid growth rates in the future. Apps, Inc.'s growth-to-date has been financed from its profits. Whenever the company had sufficient capital, it would expand by hiring more software developers and sales people. Relatively little formal analysis has been used in the capital budgeting process except for when Apps, Inc. issued a bond with a face value of $11.2 million at the beginning of the year. The bond is due in one year and covenants associated with the bond prohibit the issuance of any additional debt. The CEO would like to know about its capital budgeting and structure. Because Apps, Inc. is privately owned, it is difficult to determine the cost of equity for the company. You have determined that to estimate the cost of capital for Apps, Inc., you will use Mobile App Developers, Inc. as a representative company. Also, the CEO of Apps, Inc. would like to expand its operations by hiring more software developers, investing in more capital equipment which would require a larger space, as well as hiring more sales people. The expansion would require more hiring within administrative departments to support the expansion. However, the covenants associated with the debt issuance prohibit the issuance of more debt, so the expansion would be financed exclusively by equity at a cost of $3.6 million. The success of the expansion will depend critically on the state of the economy over the next few years.

1. Using a 7% market risk premium, what is the cost of equity for Mobile App Developers, Inc. using the CAPM?

2. Using the industry average beta, what is the cost of equity? Does it matter if you use the beta for Mobile App Developers, Inc. or the beta for the industry in this case?

3. Using the data given, what is the weighted average cost of debt for Mobile App Developers, Inc. using the book value weights or market value weights? Does it make a difference in this case if you use book value weights or market value weights?

4. Calculate the weighted average cost for capital for Mobile App Developers, Inc. using book value weights and market value weights, assuming Mobile App Developers, Inc. has a 35% marginal tax rate. Which cost of capital number is more relevant?

5. As the new CFO, you used Mobile App Developers, Inc. as a representative company to estimate the cost of capital for Apps, Inc. Explain what some of the potential problems are with this approach in this situation. What improvements, might you suggest?

6. Using the data given about Apps, Inc. expansion plans, what is the expected value of the company in one year, with and without expansion? Would the company's stockholders be better off with or without expansion? Why?

7. What is the expected value of Apps, Inc.'s debt in one year, with and without the expansion?

8. One year from now, how much value creation is expected from the expansion? How much value is expected for stockholders? Bondholders?