Pitt Beverage (PB) Capital Cost
Finance-Moeller
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PB is a publicly listed brewery and bottling company. The firm uses standard weighted average cost of capital (WACC) and CAPM calculations to find its cost of capital. The firm has two divisions. The brewery division’s market value (V) is twice the size of the bottling division’s market value. The target-level of (long-term) debt to market value is one-third (1/3) for PB (25% for the brewery division and 50% for the bottling division respectively). Because of the firm’s relatively high level of debt, it is not reasonable to assume the beta of debt is zero but you can assume that small changes in capital structure do not affect the beta of debt. Projects undertaken by the brewery division are usually short-term (up to 1 year) projects. Bottling projects usually involve longer-term investments, averaging approximately 10 years. Use the financial information on the next page to answer the following questions (do them in order!):
- Calculate the cost of capital (RWACC) for PB.
- Calculate the cost of capital (RWACC)for the brewery division of PB.
- Calculate the cost of equity for the bottling division of PB.
- The CFO has just returned from a meeting with PB’s bankers and is seriously considering switching a large portion of debt from fixed to floating rate and altering the target capital structure to keep a constant dollar amount of debt rather than a constant proportion. How would that change your calculations above? You do not have to re-do them, just give a brief description of the difference.
Consolidated Balance Sheet for PB Corporation
(2016: in millions of dollars)
Assets 2016
Cash 1,234
Cash Equivalents 4,567
Accounts Receivables 12,345
Inventories 11,346
Total Current Assets 29,492
Net Plant Property and Equipment 60,397
Software 5,515
Other Net Fixed Assets 28,835
Total Assets 124,239
Liabilities
Accounts Payable 1,365
Deferred Income 3,575
Compensation and Benefits 4,679
Total Current Liabilities 9,619
Long-term Debt 45,000
Common Stock and Surplus 30,000
Retained Earnings 39,620
Total Stockholder Equity 69,620
Total Liabilities and Stockholder Equity 124,239
Other Financial Information for PB
Shares outstanding: 1.4billion
September 2016 closing price per share: $52
Beta[1] 2.2
Corporate Tax Rate 34%
Industry Information (All debt refers to long-term debt: DLT + E = V)
Average Debt-to-Equity ratio forbrewery companies: 0.5
Average Equity Beta forbrewery companies1: 1.6
Average Debt Beta for brewery companies: 0.3
Average Debt-to-Equity ratio for bottling companies: Unavailable
Average Unlevered Equity for bottling companies: Unavailable
Bond-market Information and Credit Spreads
Rates on long-term government bonds (10-year) 2.25%
Rates on short-term government notes (1-year) 1.0%
Market Risk Premium (RM -Rf) 6.5%
PB Debt (Brewery) Rate Premium above Government 1.75%
PB Debt (Bottling) Rate Premium above Government 2.00%
[1]Beta has been calculated using regression analysis, where stock returns of the corporation for the past 200 days are regressed on the past 200 days of returns on the S&P 500 stock market index.
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