Cost of Capital for Hubbard Computer, Inc.

You have recently been hired by Hubbard Computer, Inc. (HCI), in its relatively new treasury management department. HCI was founded eight years ago by Bob Hubbard and cur- rently operates 74 stores in the Southeast. The company is privately owned by Bob and his family, and it had sales of $97 million last year.

HCI primarily sells to customers who shop in the stores. Customers come to the store and talk with a sales representa- tive. The sales representative assists the customer in determin- ing the type of computer and peripherals that are necessary for the individual customer's computing needs. After the order is taken, the customer pays for the order immediately, and the computer is made tofill the order. Delivery of the computer averages 15 days, and it is guaranteed in 30 days.

HCI's growth to date has come from its profits. When the company had sufficient capital, it would open a new store. Other than scouting locations, relatively little formal analysis has been used in its capital budgeting process. Bob has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to de- termine its cost of capital, and Bob would like you to perform the analysis. Because the company is privately owned, it is difficult to determine the cost of equity for the company. Bob wants you to use the pure play approach to estimate the cost of capital for HCI, and he has chosen Dell as a representative company. The following questions will lead you through the steps to calculate this estimate.

QUESTIONS

Q1)Most publicly traded corporations are required to submit quarterly (10Q) and annual reports (10K) to the SEC detailing thefinancial operations of the company over the past quarter or year, respectively. These corporatefil- ings are available on the SEC website at www.sec.gov. Go to the SEC website, follow the "Search for Company Filings" link, and search for SECfilings made by Dell. Find the most recent 10Q or 10K, and download the form. Look on the balance sheet tofind the book value of debt and the book value of equity. If you look further down the report, you shouldfind a section titled "Long-term Debt and Interest Rate Risk Management" that will provide a breakdown of Dell's long-term debt.

Q2) To estimate the cost of equity for Dell, go tofinance. yahoo.com and enter the ticker symbol DELL. Follow

the links to answer the following questions: What is

the most recent stock price listed for Dell? What is the market value of equity, or market capitalization? How many shares of stock does Dell have outstanding? What is the most recent annual dividend? Can you use the divi- dend discount model in this case? What is the beta for Dell? Now go back tofinance.yahoo.com and follow the "Bonds" link. What is the yield on three-month Treasury bills? Using the historical market risk premium, what is the cost of equity for Dell using CAPM?

Q3) You now need to calculate the cost of debt for Dell. Go

to www.finra.orgymarketdata, enter Dell as the company, andfind the yield to maturity for each of Dell's bonds. What is the weighted average cost of debt for Dell using the book value weights and using the market value weights? Does it make a difference in this case if you use book value weights or market value weights?

Q4)You now have all the necessary information to calculate the weighted average cost of capital for Dell. Calculate this using book value weights and market value weights, assuming Dell has a 35 percent marginal tax rate. Which number is more relevant?

Q5)You used Dell as a pure play company to estimate the cost of capital for HCI. Are there any potential problems with this approach in this situation?