HCI's growth to date has been financed by its profits. When the company had sufficient capital, it would open a new store. Other than scouting locations, relatively little formal analysis has been used in its capital budgeting process. Bob 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 Bob would like you to perform the analysis. Since the company is privately owned, it is difficult to determine the cost of equity for the company. Bob wants you to use the pure play approach to estimating the cost of capital for HCI, and he has chosen Dell as a representative company. The following steps will allow you to calculate this estimate.

a. You now need to calculate the cost of debt for Dell. The following table provides the yield to maturity for each of Dell's bonds. What is the weighted average cost of debt for Dell using the book value weights and the market value weights? Does it make a difference in this case if you use book value weights or market value weights?

b. You now have all the necessary information to calculate the weighted average cost of capital for Dell. Calculate the weighted average cost of capital for Dell using book value weights and market value weights. Assume Dell has a 35 percent marginal tax rate. Which cost of capital number is more relevant?

c. You used Dell as a pure play company to estimate the cost of capital for HCI. Are there any potential problems with this approach in this situation? ?

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Include in Bond Watchlist Symbol DELL.GF DELL.GG DELL.GB DELL.GH Issuer Name DELL INCORPORATED DELL INCORPORATED DELL INCORPORATED DELL INCORPORATED Coupon 4.70 5.65 7.10 6.50 Maturity 04/15/2013 04/15/2018 04/15/2028 04/15/2038 Callable Yes Yes Yes Yes Ratings Moody's A2 A2 A2 A2 S&P Fitch NR NR A- A- A A A Last Sale Price 99.750 92.671 91.944 81.896 Yield 4.767 6.741 7.925 8.132 Include in Bond Watchlist Symbol DELL.GF DELL.GG DELL.GB DELL.GH Issuer Name DELL INCORPORATED DELL INCORPORATED DELL INCORPORATED DELL INCORPORATED Coupon 4.70 5.65 7.10 6.50 Maturity 04/15/2013 04/15/2018 04/15/2028 04/15/2038 Callable Yes Yes Yes Yes Ratings Moody's A2 A2 A2 A2 S&P Fitch NR NR A- A- A A A Last Sale Price 99.750 92.671 91.944 81.896 Yield 4.767 6.741 7.925 8.132

Answer rating: 100% (QA)

A 1 Calculation of WACC using Book Value Bond Symbol Book Value Weight Yield WA DELL GF 100000 025 ... View the full answer