11.11 Calculating The Cost Of Capital

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11.11 CALCULATING THE COST OF CAPITAL
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.
Required
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.
Compute the weighted-average cost of capital for each of the three companies.
Compute the unlevered market (asset) beta for each of the three companies.
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 weighted-average costs of capital differ from those computed in Requirement b?
12.10 CALCULATING FREE CASH FLOWS
The 3M Company is a global diversified technology company active in the following product markets: consumer and office; display and graphics; electronics and communications; health care; industrial; safety, security, and protection services; and transportation. At the consumer level, 3M is probably most widely known for products such as Scotch® Brand transparent tape and Post-it® notes. Exhibit 12.12 presents information from the statement of cash flows and income statement for the 3M Company for 2013 to 2015. From 2013 through 2015, 3M decreased cash and cash equivalents. The interest income reported by 3M pertains to interest earned on cash and marketable securities. 3M holds only small amounts of investments in marketable securities. 3M’s income tax rate is 35%.
Required
Beginning with cash flows from operating activities, calculate the amount of free cash flows to all debt and equity capital stakeholders for 3M for 2013, 2014, and 2015.
Beginning with cash flows from operating activities, calculate the amount of free cash flows 3M generated for common equity shareholders in 2013, 2014, and 2015.
Reconcile the amounts of free cash flows 3M generated for common equity shareholders in 2013, 2014, and 2015 from Requirement b with 3M’s uses of cash flows for equity shareholders, including share repurchases and dividend payments.
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