Ready-Parts and Advance Auto Parts

You are working as a consultant for Ready-Parts Stores (RPS), a growing auto parts retailer. RPS was founded eight years ago by Jim and Belinda Bird and their family. The Birds started in the retail auto parts business over 20 years ago, originally working for other companies. RPS now owns a regional chain of 35 stores, primarily in the Midwest and Southeastern United States. RPS has been innovative in providing parts for newer types of vehicles, including hybrids and pure electric vehicles. In addition, RPS carries the latest Advanced Driver Assistance System (ADAS) add-on equipment kits.

The company wants to expand across the U.S. and Canada. Such a move would require substantial investments in warehouses, delivery vehicles and other infrastructure. Relatively little formal analysis has been used in its capital budgeting process. For example, the company has never attempted to determine its cost of capital, and the Birds would like you to perform the analysis. Jim and Belinda want you to use the pure play approach to estimate the cost of capital for RPS, and after some discussion, you agree that Advance Auto Parts would be a representative company.

QUESTIONS

1. Most publicly traded corporations are required to submit quarterly (10-Q) and annual (10-K) reports to the SEC detailing the financial operations of the company over the past quarter or year, respectively. These corporate fillings are available on the SEC website at www.sec.gov. Go to the SEC website, click on the EDGAR - Search for Company and Individual Filings link, and look for SEC filings by Advance Auto Parts, Inc. (ticker: AAP). Find the most recent 10-Q or 10-K, and download the form. Using the balance sheet, what is the book value of long-term debt and the book value of equity?

2. To estimate the cost of equity for AAP, go to finance.yahoo.com and enter the ticker symbol. Follow the links to answer the following questions: What is the most recent stock price listed for AAP? What is the market value of equity, or market capitalization? How many shares of stock does AAP have outstanding? What is the most recent annual dividend, if any? What is the beta value for AAP?

3. Calculate the required return on AAP using the dividend growth model. Yahoo! Finance reports that analysts project a current year growth rate = 8.80% for AAP. Assuming this growth rate, what is your estimate of the required return on AAP common stock using the dividend growth model? What do you observe about the relative contribution to total return from the dividend yield as opposed to the capital gains yield?

4. Now go back to finance.yahoo.com and follow the Markets/US Treasury Bonds Rates links. What is the yield on three-month (13 week) Treasury bills? Assuming the historical market risk premium is 7.0%, what is the cost of equity for AAP using CAPM?

5. The next step is to calculate the cost of debt for AAP. Go to: finra-markets.morningstar.com. Go to the Bonds section and click on the Search

   tab. Find the yield to maturity for each of AAPs outstanding bond issues (there are only two or three - note that the current portion of long-term debt should not be included in your calculations). What is the weighted average cost of debt for AAP using book value weights and then using market value weights? (Book values can be found in the 10-K or 10-Q. Market values depend on the price (percent of par) on Morningstar multiplied by the book value but be careful about where the decimal place goes.) Does it make a difference in this case if you use book value weights or market value weights?

6. You now have the necessary information to calculate the weighted average cost of capital for AAP (for cost of equity, use the average of your dividend growth and CAPM results). Calculate the WACC using book value weights and market value weights, assuming AAP has a 21 percent tax rate. Which number is more relevant? Why?

7. Other major players in the retail auto parts space include AutoZone, Inc. and OReilly Automotive, Inc. Compare AAP to one of its competitors by selecting three or four ratios that you think are important in this industry. What differences or similarities are shown by comparing the ratios for AAP and a competitor?

8. Find at least one analyst report or established website commentary on AAP and/or the retail auto parts industry in general. Summarize the analysts or writers opinions. Based on your research, what do you think is the financial outlook for AAP in the: a) short term (1-2 years); b) medium-term (5 years); c) long-term (10-plus years)? Why?

9. How might RPS position itself for superior financial results as compared to AAP and other competitors? What steps would you recommend to management?