The Chocolate Box (TCB) Company is an American multinational company and one of the largest chocolate manufacturers
Question:
The Chocolate Box (TCB) Company is an American multinational company and one of the largest chocolate manufacturers in the world. The company also manufactures baked products such as cookies and cakes. In addition, the company is analyzing the profitability of frozen desserts. To evaluate the profitability of this new product, one of their junior finance managers, Allison, needs to determine the appropriate discount rate for this project. Her starting point is the calculation of the weighted average cost of capital (WACC) for TCB. TCB has only common stocks and bonds outstanding in the market. Information on the company’s common stock and bonds is provided below. Furthermore, TCB is in the 40% tax bracket.
Common Stock: There are 15.7 million shares of stock outstanding as of today. According to the Reuters, the beta for the company stock is 0.90. However, Allison also checks the Bloomberg database to find out that the beta for the company stock is 0.75. The returns on the market portfolio and the risk-free asset are 12% and 4%, respectively. Allison has information on dividend payments to common stockholders for several years as well. The top management plans to maintain the growth in historical dividends.
Time | Dividends |
Today (t) | $3.505 |
t-1 | 3.28 |
t-2 | 3.06 |
t-3 | 2.861 |
Bonds: TCB has $444.3 million par value bonds in total in the market. Each bond has a $1,000 par value with 30 years remaining to maturity, a 10% coupon rate, and an 8% yield to maturity. These bonds make quarterly interest payments.
a. Calculate the cost of equity for TCB.
b. State the cost of debt for TCB.
c. Calculate the WACC for the company.
d. The after-tax total cash flows for the frozen dessert project calculated by Allison are shown in the table below. The company uses a subjective ±3% risk adjustment factor to evaluate projects with risks different from the overall company risk. The company’s top management considers the investment in the frozen desserts project to be less risky than the firm’s ongoing operations. Given all this, Allison needs to determine the appropriate discount rate for this project and decide if TCB should produce frozen desserts or not.
Years | Total Cash Flows |
0 | -1,200,000.00 |
1 | 250,000.00 |
2 | 250,000.00 |
3 | 375,000.00 |
4 | 375,000.00 |
5 | 375,000.00 |
Intermediate Accounting
ISBN: 978-1260481952
10th edition
Authors: J. David Spiceland, James Sepe , Mark Nelson, Wayne Thomas