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# Calculate cost of equity and WACC

Harriston Electronics builds circuit boards for a variety of applications in industrial equipment. The firm was founded in 1983 by two electrical engineers who left their jobs with the General Electric (GE) Corporation. Its balance sheet for year-end 2006 describes a firm with \$1,184,841,000 in assets (book values) and invested capital of approximately \$2.2 billion (based on market values): (attached spreadsheet)
Harriston's CFO, Margaret L. Hines, is concerned that its new investments be required to meet an appropriate cost of capital hurdle before capital is committed. Consequently, she initiated a cost of capital study by one of her senior financial analysts, Jack Frist. Shortly after receiving the assignment, Jack called the firm's investment banker to get input on current capital costs.
Jack learned that although the firm's current debt capital required a 7.5% coupon rate of interest (with annual interest payments and no principal repayments until 2012), the current yield to maturity on similar debt had risen to 8.5%, such that the current market value of the firm's outstanding bonds had fallen to \$624,385,826. Moreover, since the firm's short-term notes were issued within the last 30 days, the 9% contract rate on the notes was the same as the current cost of credit for such notes.

a. What are Harriston's total invested capital and capital structure weights for debt and equity? (Hint: The firm has some short-term debt (notes payable) that is also interest bearing.)
b. Assuming a long-term U.S. Treasury bond yield of 5.42% and an estimated market risk premium of 5%, what is Harriston's cost of equity based on the CAPM if the firm's levered equity beta is 1.2?
c. What is your estimate of Harriston's WACC? The firm's tax rate is 35%.

#### Solution Preview

Value Weights
Notes Payable 20,000,000 0.01
Long term debt (7.5% interest paid semiannually due in 2012) \$624,385,826 0.28
Total owners' capital \$1,560,000,000 0.71

Total \$2,204,385,826 ...

#### Solution Summary

Response provides the steps to compute the cost of equity and WACC

\$2.19