Chapter 12, Problem 3CC

Summary Introduction

Case summary:

Company H is a privately held motor company. Person B, the owner of Company H invented the method of manufacturing battery for electric cars at a cheaper rate with a higher mileage. His company gained popularity and competed with other auto manufacturers. The previous year’s sales were $97,000,000. It has expanded its operations steadily whenever it had excess profits.

However, the company did not employ capital budgeting techniques. Therefore, Person B has hired Person X to determine the cost of capital of Company H. As Company H is a private company, it is difficult to determine the cost of equity. Hence, Person B suggests the use of pure play approach to determine the cost of capital. He wants Person X to refer the financials of Company D to determine its cost of capital.

Characters in the case:

• Company H: The character attempting to determine an appropriate cost of capital
• Person B: The founder of Company S
• Person X: The analyst hired by Company S
• Company D: A pure play company

Introduction:

The cost of debt refers to the return that the bondholders or lenders expect on their principal. In other words, it refers to the borrowing costs of the company.

To determine: The cost of debt