Need help calculating WACC. See attached spreadsheet (my attempt at it) as well as PDF file with information.

Step 1 Total Debt Total Equity = Annual Interest Expense = Tax Rate = (US $, in millions) $ 26,362.00 $ 28,469.00 $ 54,831.00 $ 1,283.00 28.10% Before tax cost of Debt = Annual Interest Expense = $ 1,283.00 4.87% After tax cost of Debt = Annual Interest x (1- Tax rate) = $1,283 x (1-.2810) = $ 922.48 3.50% Dividend Growth 0.7 0.78 1.1 1.5 Average dividend growth 11.43% 41.03% 36.36% 20.99% Cost of Equity = Devidend/Price + g 1.5/95 + 29.61% 31.19% Cost of Equity = risk free rate + Beta (expected return - risk free rate) 7.4% + 0.91 (12.4% - 7.4%) 11.95% Step 2 WACC 28,469 54,831 x .3119 1.66 + + 26,362 54,831 x .035 13.74 = 15.40 REVIEW OF BUSINESS & FINANCE CASE STUDIES Volume 2 Number 1 2011 GLOBAL COST OF CAPITAL: THE CASE OF GLOBAL COMPUTER SYSTEMS Rathin S. Rathinasamy, Ball State University Les Livingstone, University of Maryland Chinmoy Sahu, U21Global Graduate School-Singapore CASE DESCRIPTION Global Computer Systems (GCS) is a hypothetical multinational company in the IT industry. The company is a major player in the industry catering to clients from a variety of industries. GCS has different segments specializing in major areas of its operation. The case provides an opportunity to examine various issues that need consideration while making capital budgeting decisions. One of the significant issues is that of determining the cost of capital on the basis of which the hurdle rate is calculated in deciding whether a project is worth accepting. This forms the central issue around which the case is structured. This case is suitable for use in a core Finance courses of MBA programs, and for use in MBA and under-graduate senior level international finance courses. Ideally, the case should be distributed well before the session so that students have adequate preparation time to go through the case and visit relevant internet sources mentioned therein. The case discussion may take up anywhere between 60 minutes to 90 minutes depending on the depth to which the students are intellectually stimulated to delve into. Gordon Crown, Chief Financial Officer of GCS, would like you to help him develop a company-wide cost of capital policy that is consistent with modern finance theoretical constructs. He would also like you to provide your recommendation on the acceptability of the projects. He also feels that since stock prices often fluctuate, it would be advisable to use book value weights in computing the component capital costs and the cost of capital. However, his young deputy, Helen Chang who is a recent MBA graduate, feels that market prices are very important indicators of the health of the company and they provide very good signals to the corporation in terms of the future directions. As such, she feels that the market value weights approach would be the best approach. She is also of the opinion that the Required Rate of Return on any given project, in addition to the WACC, should also include various risk premiums like stand-alone or project specific risk which can be further broken down into political risk, repatriation risk, exchange rate risk etc. Further, she believes that the required rate of return should be increased by about 1% to allow for capital investment projects that have no cash inflows, such as pollution control equipment and safety equipment. KEYWORDS: Cost of capital, computer systems, finance education, case study JEL: A23, D24, I22 CASE INFORMATION G lobal Computer Systems (GCS) is an IT company that develops and manufactures IT products and services worldwide. Its major operating segments include Global Technology Services, Global Business Services, Software, Systems and Technology, and Global Financing. The majority of the company's enterprise business, which excludes the company's original equipment manufacturer (OEM) technology business, occurs in industries that are broadly grouped into six sectors - 1 R. S. Rathinasamy et al | RBFCS Vol. 2 No. 1 2011 financial services, public, industrial, distribution and communications as well as small and medium sized businesses. In spite of the current global financial crisis, GCS appears to be doing very well. In January of 2009, it announced better than expected fourth quarter earnings with net income of US$4.4 billion, up from US$4 billion the previous year. According to its CEO, GCS \"performed well in an extremely difficult economic environment\" in year N+4 and that the company will \"enter the year in a very strong position\". Table 1 summarizes the recent trend across some of the popular parameters. Table 1: GCS's Summary Financial Data (N+2-N+4) Consolidated results (US$, in millions) Year N+4 Year N+3 Year N+2 Net Sales $103,630.0 $ 98,786.0 $ 91,423.0 Net Sales Growth 4.91% 8.1% 0.31% Operating Profit $15,938.0 $13,516.0 $11,928.0 Operating Profit Growth Diluted EPS Excluding Extraordinary Items 17.91% 13.31% 27.21% 8.93 7.18 6.06 Growth Rate 24.37% 18.48% 23.42% The table presents a summary of consolidated results of GCS's financial data from N+2 to N+4 years. The Consolidated Income Statement of GCS is presented in Table 2 pertaining to the years, Year N through Year N+3. Table 2: GCS Income Statement (N-N+3) Values in Millions (Except for per share items) Period End Date Period Length Stmt Source Stmt Source Date Stmt Update Type Revenue Other Revenue, Total Total Revenue Cost of Revenue, Total Gross Profit Selling/General/Administrative Expenses, Total Research & Development Depreciation/Amortisation Interest Expense (Income), Net Operating Unusual Expense (Income) Other Operating Expenses, Total Operating Income Year N+3 12/31/N+3 12 Months 10-K 02/26/N+4 Updated 98,785.0 1.0 98,786.0 57,057.0 41,728.0 22,060.0 6,153.0 0.0 0.0 0.0 0.0 13,516.0 Year N+2 12/31/N+2 12 Months 10-K 02/26/N+4 Reclassified 91,423.0 0.0 91,423.0 53,129.0 38,294.0 20,259.0 6,107.0 0.0 0.0 0.0 0.0 11,928.0 Year N+1 12/31/N+1 12 Months 10-K 02/26/N+4 Reclassified 91,134.0 0.0 91,134.0 54,602.0 36,532.0 21,314.0 5,842.0 0.0 0.0 0.0 0.0 9,376.0 Year N 12/31/N 12 Months 10-K 02/27/N+3 Reclassified 96,293.0 0.0 96,293.0 60,724.0 35,569.0 20,079.0 5,874.0 0.0 0.0 0.0 0.0 9,616.0 Interest Income (Expense), Net Non-Operating Gain (Loss) on Sale of Assets Other, Net Income Before Tax -217.0 18.0 1,172.0 14,489.0 293.0 41.0 1,054.0 13,316.0 -220.0 0.0 3,070.0 12,226.0 -139.0 0.0 1,192.0 10,669.0 Income Tax - Total Income After Tax Tax rate Minority Interest Equity In Affiliates U.S. GAAP Adjustment 4,071.0 10,418.0 28.10% 0.0 0.0 0.0 3,901.0 9,415.0 4,232.0 7,994.0 3,172.0 7,497.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2 REVIEW OF BUSINESS & FINANCE CASE STUDIES Volume 2 Number 1 2011 Net Income Before Extra. Items Total Extraordinary Items Net Income 10,418.0 0.0 10,418.0 9,415.0 76.0 9,491.0 7,994.0 -60.0 7,934.0 7,497.0 -18.0 7,479.0 Total Adjustments to Net Income 0.0 0.0 0.0 0.0 Basic Weighted Average Shares Basic EPS Excluding Extraordinary Items Basic EPS Including Extraordinary Items 1,423.04 7.32 7.32 1,530.81 6.15 6.2 1,600.59 4.99 4.96 1,674.96 4.48 4.47 Diluted Weighted Average Shares Diluted EPS Excluding Extraordinary Items Diluted EPS Including Extraordinary Items 1,450.57 7.18 7.18 1,553.54 6.06 6.11 1,627.63 4.91 4.87 1,707.23 4.39 4.38 Dividends per Share - Common Stock Primary Issue Gross Dividends - Common Stock Interest Expense, Supplemental Depreciation, Supplemental 1.5 2,147.0 611.0 4,038.0 1.1 1,683.0 278.0 3,907.0 0.78 1,250.0 220.0 4,147.0 0.7 1,174.0 139.0 3,959.0 Normalised EBITDA Normalised EBIT Normalised Income Before Tax Normalised Income After Taxes Normalised Income Available to Common 18,717.0 13,516.0 14,471.0 10,405.0 10,405.0 16,911.0 11,928.0 13,275.0 9,386.0 9,386.0 14,564.0 9,376.0 12,226.0 7,994.0 7,994.0 14,531.0 9,616.0 10,669.0 7,497.0 7,497.0 4.99 4.91 1,041.0 4.48 4.39 956.0 Basic Normalised EPS 7.31 6.13 Diluted Normalised EPS 7.17 6.04 Amortisation of Intangibles 1,163.0 1,076.0 This table presents the consolidated income statement of GCS from N to N+3 years The consolidated Balance Sheet of GCS is presented in Table 3 pertaining to the years, Year N through Year N+3. Table 3: GCS Consolidated Balance Sheet (in millions) (N-N+3) Financial data in US$ Values in Millions (Except for per share items) N+3 12/31/N+3 N+2 12/31/N+2 N+1 12/31/N+1 N 12/31/N Stmt Source Stmt Source Date Stmt Update Type Assets Cash and Short Term Investments Total Receivables, Net Total Inventory Prepaid Expenses Other Current Assets, Total Total Current Assets 10-K 02/26/N+4 Updated 10-K 02/27/N+3 Updated 10-K 02/28/N+2 Updated 10-K 02/28/N+2 Restated 16,146.0 28,789.0 2,664.0 3,891.0 1,687.0 53,177.0 10,656.0 26,848.0 2,810.0 2,539.0 1,806.0 44,659.0 13,686.0 24,428.0 2,841.0 2,941.0 1,765.0 45,661.0 10,570.0 28,136.0 3,316.0 2,708.0 2,413.0 47,143.0 Property/Plant/Equipment, Total - Net Goodwill, Net Intangibles, Net Long Term Investments Note Receivable - Long Term Other Long Term Assets, Total Other Assets, Total Total Assets 15,082.0 14,285.0 2,107.0 5,248.0 11,603.0 18,930.0 0.0 120,432.0 14,439.0 12,854.0 2,203.0 4,501.0 10,068.0 14,509.0 0.0 103,233.0 13,756.0 9,441.0 1,663.0 3,142.0 9,628.0 22,457.0 0.0 105,748.0 15,175.0 8,437.0 1,789.0 2,444.0 10,950.0 25,065.0 0.0 111,003.0 Liabilities and Shareholders' Equity Accounts Payable Payable/Accrued Accrued Expenses Notes Payable/Short Term Debt Current Port. of LT Debt/Capital Leases 8,054.0 0.0 10,546.0 8,545.0 3,690.0 7,964.0 0.0 9,967.0 6,134.0 2,768.0 7,349.0 0.0 8,558.0 4,228.0 2,988.0 9,444.0 0.0 10,340.0 4,491.0 3,608.0 Period End Date 3 R. S. Rathinasamy et al | RBFCS Vol. 2 No. 1 2011 Other Current Liabilities, Total Total Current Liabilities 13,475.0 44,310.0 13,257.0 40,090.0 12,029.0 35,152.0 11,903.0 39,786.0 Total Long Term Debt Deferred Income Tax Minority Interest Other Liabilities, Total Total Liabilities 23,039.0 1,064.0 0.0 23,549.0 91,962.0 13,780.0 665.0 0.0 20,192.0 74,727.0 15,425.0 1,616.0 0.0 20,457.0 72,650.0 14,828.0 1,770.0 0.0 22,931.0 79,315.0 Redeemable Preferred Stock Preferred Stock - Non Redeemable, Net Common Stock Retained Earnings (Accumulated Deficit) Treasury Stock - Common Other Equity, Total Total Equity 0.0 0.0 35,188.0 60,640.0 -63,945.0 -3,414.0 28,469.0 0.0 0.0 31,271.0 52,432.0 -46,296.0 -8,901.0 28,506.0 0.0 0.0 28,926.0 44,734.0 -38,546.0 -2,016.0 33,098.0 0.0 0.0 26,673.0 38,148.0 -31,072.0 -2,061.0 31,688.0 Total Liabilities & Shareholders' Equity 120,431.0 103,233.0 105,748.0 111,003.0 1,573.98 0.0 1,645.59 0.0 Total Common Shares Outstanding 1,385.23 1,506.48 Total Preferred Shares Outstanding 0.0 0.0 This table presents the consolidated balance sheet of GCS from N to N+3 years The detailed composition of total long term debt of US$ 23,039 million reported on the consolidated Balance Sheet for the year N+3 is presented in Table 4. The table provides details for debt securities of various maturities along with the coupon rates payable on them. Table 4: Details of Long-Term Debt (US$, in millions) Coupon Interest Rate 4.48% 5.34% 5.69% 8.375% 7.00% 6.22% 6.50% 5.875% 7.00% 7.125% Other currencies (average interest rate at December 31, N+3, in parentheses) Euros (3.4%) Yen (2.2%) Swiss francs (1.5%) Other (2.7%) Weighted average interest rate = $1,283/$26,362 = 4.87% Less: Net unamortized discount Add: SFAS No. 133 fair value dj Maturities N+4-N+7 N+8-N+9 N+10-N+14 N+15 N+21 N+23 N+24 N+28 N+41 N+92 Balance on N+3 $12,295*** 3,545 3,026 750 600 469 313 600 150 850 Annual Interest Expense $551 189 172 63 42 29 20 35 11 61 N+4-N+9 N+6-N+10 N+4 N+4-N+9 2,466 767 442 89 84 17 7 2 26,362 1,283 65 432 26,729 Less: Current maturities 3,690 Total 23,039 This table provides a detailed break-down of the composition of Long-term debt of GCS reported on its consolidated Balance Sheet for the year N+3 All GCS bonds are rated Aaa by Moody's and AAA by Standard & Poor's. Interpretation of bond rating categories normally assigned by both the credit rating agencies are summarized in Table 5. 4 REVIEW OF BUSINESS & FINANCE CASE STUDIES Volume 2 Number 1 2011 Table 5: Credit Rating Categories Rating Description Moody's Ratings Standard & Poor's Ratings Highest Quality Aaa AAA High Quality Aa AA Upper Medium A-1, A A Medium Baa-1, Baa BBB Speculative Ba BB Highly Speculative B,Caa B, CCC, CC Default Ca, C D The table describes the interpretation of various categories assigned by two credit rating agencies. Rating Grades Investment Grade Not Investment Grade Currently, in the capital budgeting arena, each GCS division has its own method of calculating the cost of capital resulting in different hurdle rates; thus, it leads to non-uniformity with regard to accept/reject decisions on capital investments. GCS feels that in order to maximize shareholder value, it has to come up with company-wide guidelines for calculating its cost of capital and standardize the hurdle rates and accept/reject decisions throughout the company. For the year N+6, GCS is considering the following capital budgeting projects with these projects spread around the globe: Table 6: GCS's N+6 New Projects Under Consideration Project Proposed Location Estimated IRR Type of Project 1 Net Investment Cost (US$, in millions) $500 Europe 26.3% 2 $400 USA 13.5% 3 $650 Asia 8.6% 4 $1,500 Asia 23.4% 5 $350 USA 24.6% Existing product, new market New product, new market Expand existing product in existing market New product, existing market Replace Equipment 6 $750 Europe 10.2% 7 $250 Asia 26.7% 8 $325 Asia 18.8% Expand existing product in existing market Existing product, new market New product, existing market This table provides details of new projects under consideration by GCS in year N+6 Further, GCS has a total budget allocation (capital constraint) of US$4.2 billion for the N+6 capital investment budget. Project risk tends to vary with project type, as described in table 7. Table 7: Type of project and degree of risk Type of Project Degree of Risk Routine replacement of equipment Minimal Cost reduction Low Expand existing products in existing markets Moderate Add new products in existing markets Moderate-High Expand existing products in new markets Moderate-High Add new products in new markets High This table describes the risk profiles of different kinds of projects normally undertaken by businesses. You have been provided with an excellent opportunity to assist Gordon Crown and Helen Chang in your first exposure to a real world scenario. Having recently completed MBA Finance from a leading University, this is your best chance to launch your career in corporate finance by applying relevant concepts that you may have come across in the class room discussions at your University. A further 5 R. S. Rathinasamy et al | RBFCS Vol. 2 No. 1 2011 challenge is to justify the basis of your analysis in the most convincing manner to address Helen Chang's concerns, being an MBA herself. Gordon Crown is now eagerly awaiting your recommendations. QUESTIONS After a quick glance at the available information and the decision making requirements of the Gordon Crown, you have decided that at the minimum you have to do the following: Question 1: For component costs: A. Compute the before- and after-tax costs of GCS debt. B. Compute the cost of equity (assuming all funds come from internal sources): i. Using the constant growth Gordon Dividend Valuation Model ii. Using the Security Market Line Equation (SML) from the Capital Asset Pricing Model (CAPM) Question 2: Compute the Weighted Average Cost of Capital (WACC) based on cost of equity estimated under the Gordon's Constant Growth Dividend Valuation Model: A. Using book value weights for debt and equity B. Using market value weights for debt and equity Question 3: Compute the WACC based on cost of equity estimated under the CAPM: A. Using book value weights for debt and equity B. Using market value weights for debt and equity Question 4: Address the pros and cons of using market value weights versus book value weights and reconcile the divergent views of Crown and Chang. Question 5: Compute the Required Rate of Return for the project(s), adding appropriate risk premiums subjectively to the WACC's in questions 2 and 3. These risk premiums can differ depending on the nature and continental location of the projects. Question 6: Make a recommendation as to which, if any, of the investments identified in Table 6 should be accepted taking into account the capital constraint. APPENDIX i. GCS is part of several stock market indices such as the Dow Jones Composite Average, S&P 100, S&P 500 and S&P Composite 1500. ii. The long-run average return on the S&P 500 Index is 12.4%. iii. T-bills and T-bill rates can be found in Bonds Online (http://www.bondsonline.com/Todays_Market/Treasury_Yield_Curve.php). iv. The beta of GCS is 0.91. Use 5% for the equity premium (sometimes called the market risk premium) which is the market-wide premium demanded by investors for investing in stocks rather than in virtually risk-free U.S. Treasury securities. GCS common stock is presently trading at $95 per share. v. You can find daily interest rates for Moody's Aaa bonds at the following website http://www.federalreserve.gov/releases/h15/Update/. Essentially, you can find the current market value for the bonds listed in Table 4 by using these daily interest rates. For the foreign currency bonds listed in 6 REVIEW OF BUSINESS & FINANCE CASE STUDIES Volume 2 Number 1 2011 Table 4, you have to use the book values in place of market values. You may want to recall that corporate bonds have a face value of $1,000 unless otherwise stated. Bond interest is normally paid twice yearly on June 30 and December 31. Assume that all bonds mature on December 31. vi. Include charts and tables, where appropriate. Clearly state your assumptions and provide detailed calculations, where necessary. BIOGRAPHY Dr. Rathin S. Rathinasamy is a Professor of Finance at Ball State University. He can be contacted at Department of Finance, Ball State University, Muncie, IN, 47306, USA. E-mail: rsrathin@bsu.edu Dr. Les Livingstone is a Professor and MBA Director at the University College, University of Maryland. He can be contacted at University College, University of Maryland, Adelphi, MD, 20783, USA. E-mail: jlivingstone@umuc.edu Dr. Chinmoy Sahu is an Assistant Professor of Finance at U21Global Graduate School. He can be contacted at U21Global Graduate School, Singapore. E-mail: chinmoy.sahu@u21global.edu.sg 7 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission