Divisional Cost of Capital for Diageo's investments
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1. Diageo subtracts the value of its portfolio of short-term investments, which is held outside the United States and is not required to support day-to-day operations, from its total debt when calculating its "net debt ratio." Use Diageo's net debt ratio to calculate Diageo's overall WACC.
2. Should Diageo use its overall cost of capital to evaluate its restaurant investments? Under what circumstances would it be correct to do so?
3. Estimate the cost of capital for Diageo's restaurant businesses.
4. Explain why there is a difference between Diageo's overall cost of capital and the cost of capital for its restaurant businesses.
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Solution Summary
The divisional cost of capital for Diageo's investments are examined.
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Answer:
1. Given that,
Common share outstanding =788 million
Year-end share price=$55.875
Value of equity=788*$55.875=$44,029.5 million
Long term debt=$8,747 million (market value)
So value of the firm=$44,029.5+$8,747=$52,776.5
So,
Now,
For equity:
Diageo's beta=1.00
Average risk free rate of return=(5.13%+5.50%+6.00%)/3=5.54%
Average market risk premium=(8.40%+7.40%+7.00%)/3=7.6%
Therefore,
For Debt:
Diageo's long-term borrowing rate=6.75%
Income tax rate=34%
Therefore,
Hence,
2. It is not correct to use overall WACC for the evaluation of ...
Education
- MBA, Indian Institute of Finance
- Bsc, Madras University
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