Cost of Capital for Swan Motors The Cost of Capital for Swam Motors, Inc. Revised You have recently been hired by Swan Motors, Inc. (SMI), in its relatively new treasury management department. SMI was founded eight years ago by Joe Swan. Joe found a method to manufacture a cheap battery with much greater energy density than was previously possible, giving a car powered by the battery a range of 700 miles before requiring a charge. The cars manufactured by SMI are midsized and carry a price that allows the company to compete with other mainstream auto manufacturers. The company is privately owned by Joe and his family, and it had sales of $97 million last year. SMI primarily sells to customers who buy the cars online, although it does have a limited number of company-owned dealerships. Most sales are online. The customer selects any customization and makes a deposit of 20 percent of the purchase price. After the order is taken, the car is made to order, typically within 45 days. SMIs growth to date has come from its profits. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Joe has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Joe 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. Joe wants you to use the pure play approach to estimate the cost of capital for SMI, and he has chosen Tesla Motors as a representative company. The following questions will work you through the steps to calculate this estimate.

Question:

1. You used Tesla as a representative company to estimate the cost of capital for SMI. What are some of the potential problems with this approach in this situation? What improvements might you suggest?