Whirlpool manufactures and sells home appliances under various brand names. IBM develops and manufactures computer hardware and offers related technology services. Target operates a chain of general merchandise discount retail stores. The data in the following table apply to these companies (dollar amounts in millions). For each firm, assume that the market value of the debt equals its book value.
Whirlpool IBM Target Stores
Total assets...........................................$13,532....$109,524................$44,106
Interest-bearing debt.................................$ 2,597......$ 33,925...............$18,752
Average pretax borrowing cost........................6.1%.............4.3%.........................4.9%
Common equity:
Book value............................................$ 3,006......$ 13,465...............$13,712
Market value..........................................$ 2,959......$110,984...............$22,521
Income tax rate........................................35.0%............35.0%.......................35.0%
Market equity beta.......................................2.27............0.78....................1.20
REQUIRED
a. Assume that the intermediate-term yields on U.S. government Treasury securities are
3.5%. Assume that the market risk premium is 5.0%. Compute the cost of equity capital for each of the three companies.
b. Compute the weighted-average cost of capital for each of the three companies.
c. Compute the unlevered market (asset) beta for each of the three companies.
d. Assume that each company is a candidate for a potential leveraged buyout. The buyers intend to implement a capital structure that has 75% debt (with a pretax borrowing cost of 8.0%) and 25% common equity. Project the weighted-average cost of capital for each company based on the new capital structure. To what extent do these revised weightedaverage costs of capital differ from those computed in Requirement b?