You have recently been hired by Robert Computer, Inc. (RCI), in its relatively new treasury management department. RCI was founded eight years ago by Bob Robert and currently operates 74 stores in the Southeast. The company is privately owned by Bob and his family, and it had sales of $100 million last year. RCI primarily sells to customers who shop in the stores. Customers come to the store and talk with a sales representative. The sales representative assists the customer in determining the type of computer and peripherals that are necessary for the individual customers computing needs. After the order is taken, the customer pays for the order immediately, and the computer is made to fill the order. Delivery of the computer averages 15 days, and it is guaranteed in 30 days. RCIs 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 determine its costs 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 RCI, and he has chosen Apple as a representative company. The following questions will lead you through the steps to calculate this estimate: 1. Debt and equity: Most publicly traded corporations are required to submit quarterly (10Q) and annual reports (10K) to the SEC detailing the financial operations of the company over the past quarter or year, respectively. These corporate filings are available on the SEC Web site at www.sec.gov. Go to the SEC Web site; follow the Filings-Company Filings Search link; enter Apple Inc; and search for SEC filings made by Apple. Find the most recent 10-K, and download the form. Look on the balance sheet and you can find the book value of debt. If you look further down the report, you should find a section titled NOTES TO CONSOLIDATED FINANCIAL STATEMENTS that will provide a breakdown of Apples long-term debt for book value. What is the total book value of long term debt? What is the total book value of all the fixed-rate notes? 2. To estimate the cost of equity for Apple (1) Go to finance.yahoo.com and enter the ticker symbol AAPL. Follow the links to answer the following questions: What is the most recent stock price listed for Apple? What is FIN202 Instructor: Dr. Yudan Zheng the market value of equity, or market capitalization? What is the most recent annual dividend? How many times that dividends have been paid in the history of Apple? Can you use the dividend discount model in this case? What is the beta for Apple? (2) Now go back to finance.yahoo.com and follow the Markets - US Treasury Bonds Rates link. What is the yield on three-month (13-week) Treasury bills? (Note: The numbers in the table are in percentage format.) Using the historical market risk premium 8%, what is the cost of equity for Apple using CAPM? 3. You now need to calculate the cost of debt for Apple. Go to http://finramarkets.morningstar.com/BondCenter/Default.jsp, enter Apple Inc as the company, and find the following information for each of Apples fixed-rate bonds: bond symbol, maturity, coupon rate, book value, bond price, and yield to maturity. What is the weighted average cost of debt for Apple using the market value of bonds as the weights? Hint: Bond price has been provided in the percentage of the face value (book value). When you click each bond symbol, you can see the book value of each bond is listed as Original Offering. Yield for each bond has also been provided, in percentage format. You just need to calculate the weighted average yield to maturity by using the market value of each bond as the weight. Note: The website shows all the outstanding bonds that Apple has, including floating-rate bonds and fixed-rate bonds. However, please include only the fixed-rate bonds in your calculation. 4. You now have all the necessary information to calculate the weighed average cost of capital for Apple. Calculate this using market value weights, assuming Apple has 35 percent marginal tax rate. 5. You used Apple as a pure play company to estimate the cost of capital for RCI. Are there any potential problems with this approach in this situation?