You have recently been hired by Master Tools (MT) in its relatively new treasury management department. MT was founded eight years ago by Martha Masters. Martha found a method to streamline the manufacturing process, resulting in a cheaper tool. The tools manufactured by MT are designed for the mass market and sold primarily through retail. The company is privately owned by Martha and her family, and it had sales of $97 million last year.

MT primarily sells to do-it-yourself (DIY) customers who use the tools for personal projects, although it does sell through various online marketplaces. As a result, the company’s sales are price sensitive. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Martha 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 Martha 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. Martha wants you to use the pure play approach to estimate the cost of capital for MT, and she has chosen Snap-On Incorporated as a representative company. The following questions will lead you through the steps to calculate this estimate.

1. Most publicly traded corporations are required to submit 10-Q (quarterly) and 10-K (annual) reports to the SEC detailing their financial operations over the previous quarter or year, respectively. These corporate filings are available on the SEC website at www.sec.gov. Go to the SEC website, follow the “Search SEC.gov” box, and search for SEC filings made by Snap-On (SNA). Find the most recent 10-Q or 10-K, and download the form. Look at the balance sheet to find the book value of debt and the book value of equity.

2. To estimate the cost of equity for SNA, go to finance.yahoo.com and enter the ticker symbol “SNA.” Follow the links to answer the following questions: What is the most recent stock price listed for SNA? What is the market value of equity, or market capitalization? How many shares of stock does SNA have outstanding? What is the forward annual dividend? Analysts have estimated a 6 percent growth rate for dividends. What is the cost of equity for SNA using the DDM? What is the beta for SNA? Now go back to finance.yahoo.com and follow the “Bonds” link. What is the yield on three-month Treasury bills? Using the historical market risk premium, what is the cost of equity for SNA using CAPM? What is your final estimate for the cost of equity?

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 SNA or the beta for the industry in this case?

4. You now need to calculate the cost of debt for SNA. Go to finra-markets.morningstar.com/BondCenter, enter SNA as the company, and find the yield to maturity for each of SNA’s bonds. What is the weighted average cost of debt for SNA using the book value weights and using the market value weights? Does it make a difference in this case if you use book value weights or market value weights?

5. You now have all the necessary information to calculate the weighted average cost of capital for SNA. Calculate the WACC using book value weights and market value weights. SNA has a 21 percent tax rate. Which number is more relevant?

6. You used SNA as a pure play company to estimate the cost of capital for MT. Are there any potential problems with this approach in this situation? What improvements might you suggest?