Hill Country Foods.Co
On this basis, the most commonly accepted method for calculating cost of equity comes from the capital asset pricing model (CAPM): The cost of equity is expressed formulaically below: Re = rf + (rm – rf) * β
Where: •Re = the required rate of return on equity •rf = the risk free rate •rm – rf = the market risk premium •β = beta coefficient = unsystematic risk
The risk free rate can be set as 10-yrs treasury bond rate, which is 1.8%. And market return is set up to be 10%.Beta changes as the debt ratio changes. See the figure 2 below
Beta unlevered =1, and Batas levered are calculated in the excel. And we can get cost of equity by CAPM to calculate WACC. Then, the firm value can also be calculated. We assume the growth rate of FCF is 8.2% which is the annual growth rate of sales in 2011.
From the table above, we can see that with 20% debt to capital ratio, the company will have the lowest WACC 9.27% and highest firm value of $9894.338. Therefore, a 40% of debt should recommend to Hill Country’s capital structure.
After the restructure of capital structure, the business risk will increase because the bankruptcy risk will rise long with debt. The two problems from agency theory will come to front, since the decisions are not solely made by shareholder, the control has been diluted. There will be much less dividends payment, and the retained earning can be used for expansion and future growth. More