The Question

Shin Lee was a recent immigrant to Canada and current Commerce student at the Smith School of Business. He had some family money to invest and wanted to use the skills he was developing at Smith wisely. He had heard a great deal about recent turmoil at Bombardier, and this news had piqued his interest. Lee knew often a company in trouble was a good buy, particularly if the future looked bright.

Did Bombardier's future look bright? The answer to that question depended, in part, on the company's Weighted Average Cost of Capital (WACC), and it was to that which Lee turned his mind before making an investment decision. He had learned in his finance class the WACC would inform profitability going forward.

Lee's research from Bloomberg indicated Bombardier's Beta was 1.431 and the Market Risk Premium was 5.96 per cent. He set out to calculate the weight of equity for Bombardier based on the closing share price as of December 31, 2018 (the last trading day of 2018). Share price information was available at Bombardier Investor Relations. By looking at the 2018 Annual Report (available as an additional resource), Lee could determine the number of shares outstanding of both preferred and common shares (see page 149 of the Annual Report) and exchange rates (see page 148 of the Annual Report). The exchange rate is important because the values in the Annual Report are in USD whereas the share prices are in CAD. He will need then to convert the USD values to CAD. He assumed the company's effective tax rate was 17.88 per cent (an average of the last 4 years that Bombardier had a positive tax rate). For the same day, December 31, 2018, Lee researched the Canadian 10-year bond yield at the Bank of Canada, which would be necessary in calculating the cost of equity for Bombardier. He found that this yield was 1.96%.

Lee expected to incorporate the range of preferred shares and their most recent dividend payouts (see page 150 of the Annual Report) into his cost of capital calculations. He assumes that the growth rate of the preferred shares dividends is zero. He also assumes that both Class A and Class B shares have the same cost of equity. When calculating the cost of debt, he would include the company's long-term debt (see page 224 of the Annual Report). For the debt that has no value for December 31st, 2018 (it is represented as a dash) he assumes that the market value is 0 (i.e., it has been paid off). He further assumed that the amounts of long-term debt on page 224 of the Annual Report (the column with header December 31st, 2018) were the best estimates of the market values in USD. Finally, Lee's research on Bloomberg gave him the bond prices for all of Bombardier's long term debt (see Table 1; the face value is 100). The bond prices are necessary for the computation of the YTM of each bond with the exception of the "Other" entry, the cost of which for December 31st, 2018 was explained in a footnote (see page 224 of the Annual Report). One issue is how to handle fractional years for bond maturities, especially knowing that they are semi-annual bonds. For simplicity, he decided to round the number of periods when computing the YTM of each bond, as seen in Table 1. Using his knowledge of finance, he sat down to punch the numbers and calculate Bombardier's WACC.

Table 1 - Bombardier Bond Prices as of December 31, 2018

Issue	Price	Years to Maturity
March, 2020 7.75%	101.61	1
May, 2021 6.125%	101.84	2
December, 2021 8.75%	103.18	3
March, 2022 5.75%	94.24	3
October, 2022 6.00%	94.40	4
January, 2023 6.13%	94.46	4
December, 2024 7.50%	95.29	6
March, 2025 7.50%	94.35	6
May, 2034 7.45%	89.55	15
December, 2026 7.35%	93.33	8