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QUESTIONS 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 oper- ations, 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 evalu- ate its restaurant investments? Under what circum- stances 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. A recent annual report for Diageo PLC explains that its cream; alcoholic beverages, such as Seagrams; and restau- investments are expected to generate cash returns that rants, such as Burger King. Diageo did not report costs of exceed its long-term cost of capital, which Diageo esti- capital separately for these three businesses. Information mated to be approximately 10%. Diageo has three main from the annual report is given here, followed by relevant lines of business: food items, such as Haagen Dazs ice market data. $1,498 million (approximates market value) $706 million (approximates market value) $8,509 million ($8,747 million market value) 788 million $55.875 34% Financial information: Cash and marketable securities Short-term debt Long-term debt Common shares outstanding Year-end share price Income tax rate Market data: Diageo's beta Diageo's long-term borrowing rate Riskless returns: Short term Intermediate term Long term Market risk premium: Short term Intermediate term Long term 1.00 6.75% 5.13% 5.50 6.00 8.40% 7.40 7.00 The following table provides information concerning publicly traded restaurant firms. TOTAL DEBT ($ MILLIONS) PREFERRED STOCK ($ MILLIONS) COMMON SHARES (MILLIONS) CLOSING STOCK PRICE FIRM STOCK LISTED BETA Applebee's Bob Evans Farms Brinker International CKE Restaurants McDonald's NPC International Shoney's Wendy's International NASDAQ NASDAQ NYSE NYSE NYSE NASDAQ NYSE 1.30 0.95 1.70 1.15 1.00 0.80 0.90 1.15 28.5 54.7 104.7 86.7 4,820.1 81.4 440.4 147.0 31.0 42.3 72.1 18.4 694.0 24.5 41.5 103.4 $22.750 19.000 15.125 16.000 45.125 7.250 10.250 21.250 411.1 NYSE