Calculate the cost of capital of equity (RE)

COST OF CAPITAL FOR SWAN MOTORS
You have recently been hired by Swan Motors, Inc. (SMI), in its relatively new treasury
management department. SMI was founded eight years ago by Joe Swan. Joe found a method to
manufacture a cheaper battery that will hold a larger charge, giving a car powered by the battery a
range of 700 miles before requiring a charge. The cars manufactured by SMI are midsized and
carry a price that allows the company to compete with other mainstream auto manufacturers. The
company is privately owned by Joe and his family, and it had sales of $97 million last year.
SMI primarily sells to customers who buy the cars online, although it does have a limited number
of company-owned dealerships. The customer selects any customization and makes a deposit of
20 percent of the purchase price. After the order is taken, the car is made to order, typically within
45 days. SMI’s growth to date has come from its profits. When the company had sufficient capital,
it would expand production. Relatively little formal analysis has been used in its capital budgeting
process. Joe has just read about capital budgeting techniques and has come to you for help. For
starters, the company has never attempted to determine its cost of capital, and Joe 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. Joe wants you to use the pure play approach to estimate the cost
of capital for SMI, and he has chosen Tesla Motors as a representative company. SMI tax rate is
21%. The following questions will lead you through the steps to calculate this estimate.
Using the information provided in Appendix A:
1. Calculate the cost of capital of equity (RE) using Tesla’s industry beta and the CAPM model.
(25 points)
2. Calculate the cost of capital of Debt (RD) as one group, before and after tax, using the bonds’
market values. (40 points)
3. Calculate Tesla’s Weighted Average Cost of Capital. Specifically, use the market values of D
and E. (35 points)
2
Appendix A – TESLA’s financial inputs required to answer for questions 1-3
Equity and Bond Balance sheet information:
– The book value of equity is $1,315 million on the balance sheet, where the book value per share
is $10.13
– The company issued $920 million face value of 2021 bonds
– The company issued $1,380 million face value of 2022 bonds
– Balance sheet Debt/Equity ratio is 1.749
Equity Market information:
– Shares outstanding = 129.80 million
– Stock price = $232.357
– Market capitalization = $30159.94 million
– Industry Beta = 1.10
– 3-month Treasury bill rate is 0.50% and the market risk premium is 7%.
Bond Market information:
Face value
(millions)
Quoted
price
Quoted
Yield
3/1/2021 $920 94.347 2.028%
3/1/2022 1,380 92.625 2.754%
Total $2,300

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