Chapter $7$ Minicase

Prepare the calculations in excel and upload the file.

Castillo Products Company

The Castillo Products Company was started in $2017.$ The company manufactures components for personal digital assistant $($PDA$)$ products and for other handheld electronic products. A difficult operating year, $2018,$ was followed by a profitable $2019.$ The founders $($Cindy and Rob Castillo$)$ are interested in estimating their cost of financial capital because they are expecting to secure additional external financing to support planned growth.

Short$-$term bank loans are available at an $8$ percent interest rate. Cindy and Rob believe that the cost of obtaining long$-$term debt and equity capital will be somewhat higher. The real interest rate is estimated to be $2$ percent, and a long$-$run inflation premium is estimated at $3$ percent. The interest rate on long$-$term government bonds is $7$ percent. A default$-$risk premium on long$-$term debt is estimated at $6$ percent; plus Castillo Products is expecting to have to pay a liquidity premium of $3$ percent due to the illiquidity associated with its long$-$term debt. The market risk premium on largefirm common stocks over the rate on long$-$term government bonds is estimated to be $6$ percent. Cindy and Rob expect that equity investors in their venture will require an additional investment risk premium estimated at two times the market risk premium on large$-$firm common stocks.

Following are income statements and balance sheets for the Castillo Products Company for $2018$ and $2019.$

CASTILLO PRODUCTS COMPANY

INCOME STATEMENT

Net sales

Cost of goods sold

Gross profit

Marketing

General and administrative

Depreciation

EBIT

Interest

Earnings before taxes

Income taxes

Net income $($loss$)$

$1$

BALANCE SHEET

$2018$

$\backslash$table$[[$$$900,000,$$$1,500,000$