You have recently been hired by Goff Communica-tions Inc. (GCI) in the finance area. GCI was founded 20 years ago by Chris Goff and currently employs over 30,000 workers. GCI is privately owned by Chris and her family and had sales of $8.6 billion last year. GCI provides telecommunication products and services, including wireless, data, Internet, and television, to businesses and households.
GCI’s growth to date has been financed from its profits. Whenever the company had sufficient capital, it would open a new store. Relatively little formal analysis has been used in the capital budgeting process. Chris has just read about capital budgeting techniques and has come to you for help. The company has never attempted to determine its cost of capital, and Chris 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. You have determined that to estimate the cost of capital for GCI, you will use Telus Corporation (T) as a representative company. The following steps will allow you to calculate this estimate:
1. Most publicly traded corporations are required to submit quarterly and annual reports to the Ontario Securities Commission (OSC) detailing their financial operations over the previous quarter and year, respectively. These corporate filings are available on the SEDAR website. Go to www.sedar.com and follow the Search Database link and then the Search for Public Company Documents link. Enter the company name, Telus Corporation, and search for filings made by the company. Find and download the company’s most recent quarterly or annual report. Look on the balance sheet to find the book value of debt and the book value of equity. If you look farther down the report, you should find a section titled either “Long-Term Debt” or “Long-Term Debt and Interest Rate Risk Management” that will list a breakdown of Telus Corporation’s long-term debt.
2. To estimate the cost of equity for Telus, go to www.google.ca/finance and enter “TSE.T,” the ticker symbol for Telus. Follow the various links to find answers to the following questions. What is the most recent stock price listed for Telus? What is the market value of equity, or market capitalization? How many shares of stock does Telus have outstanding? What is the beta for Telus? Now go to www.canpxonline.ca/quotes.php and follow the “Canadian Benchmark Yields” link. What is the yield on 3-month Treasury bills? Using a 7 percent market risk premium, what is the cost of equity for CMG using the CAPM?
3. Go to www.reuters.com and find the list of competitors in the industry. Find the beta for each of these competitors, and then calculate the industry average beta. Using the industry average beta, what is the cost of equity? Does it matter if you use the beta for Telus Corporation or the beta for the industry in this case?
4. You now need to calculate the cost of debt for Telus. Go to www.canpxonline.ca/quotes.php; under the “CanPX Trades” link there will be a table listing outstanding Canadian Corporate bonds. Search for “Telus Corp” in the table and find the YTM for each of Telus Corporation’s bonds. What is the weighted average cost of debt for Telus using the book value weights and the market value weights? Does it make a difference in this case whether you use book value weights or market value weights?
5. You now have all the necessary information to calculate the WACC for Telus. Calculate the WACC for Telus using book value weights and market value weights, assuming Telus has a 35 percent marginal tax rate. Which cost of capital number is more relevant?
6. You used Telus Corporation as a representative company to estimate the cost of capital for GCI. What are some of the potential problems with this approach in this situation? What improvements might you suggest?