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In: Accounting

You have recently been hired by Bio Lux Company, in its relatively new treasury management department....

You have recently been hired by Bio Lux Company, in its relatively new treasury management department. Bio Lux was founded five years ago by Jessica Parker. Jessica found a method to produce high quality shampoo using natural ingredients. The shampoo produced by Bio Lux is in a good position to compete with other more established shampoo producers. The company is privately owned by Jessica Parker and her family, and it had sales of $12 million last year.

Bio Lux primarily sells its products through a wholesaler who distributes the products through its network of retailers throughout the country. Bio Lux’s growth to date has come from its innovation, quality, and low costs. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Jessica 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 Jessica 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. Jessica wants you to use a similar company to estimate the cost of capital (WACC) for Bio Lux, and she has chosen Procter & Gamble as a representative company. The following questions will lead you through the steps to calculate this estimate.

1. To estimate the cost of equity for Procter & Gamble, go to finance.yahoo.com and enter the ticker symbol “PG.” Follow the various links at this website to find answers to the following questions:

a) What is the most recent stock price (and provide the associated date) listed for Procter & Gamble?

b) What is the market value of equity, or market capitalization?

c) How many shares of stock does Procter & Gamble have outstanding?

d) What is the beta for Procter & Gamble?

e) Now go back to finance.yahoo.com and follow the “Bonds” link. What is the yield on three-month Treasury bills? Using a 6 percent market risk premium, what is the cost of equity for Procter & Gamble using the CAPM?

Expert Solution

The answers to the questions are as follows:

a) What is the most recent stock price (and provide the associated date) listed for Procter & Gamble?

When we say stock price, we generally take closing stock price. Closing stock price for 'PG' for 19th March 2019 is $101.90.

b) What is the market value of equity, or market capitalization?

Market capitalization for PG is $253.91 Bn. Market capitalization = 'Shares outstanding' * 'Market Price per share'. 'Share outstanding' are taken from the most-recently filed quarterly or annual report.

c) How many shares of stock does Procter & Gamble have outstanding?

Shares outstanding for PG are 2.5 Bn.

d) What is the beta for Procter & Gamble?

Beta for PG is 0.22

e) Now go back to finance.yahoo.com and follow the “Bonds” link. What is the yield on three-month Treasury bills? Using a 6 percent market risk premium, what is the cost of equity for Procter & Gamble using the CAPM?

Yield on three-month (13 WEEKS) Treasury bill = 2.415%

Cost of Equity can be calculated using CAPM through following formula

ER_i = R_f + β_i * (ER_m - R_f)

Where,

ER_i = Expected rate of return (Cost of Equity in our case)

R_f = Risk free rate of return (3 month treasury bill yield in our case)

β_i = Beta for the company

(ER_m - R_f) = Market risk premium.

Therefore the cost of Equity for Procter & Gamble would be calculated as follows:

ER_i = R_f + β_i * (ER_m - R_f)

= 2.415% + 0.22 * 6%

= 2.415% + 1.32%

= 3.735%

ekkarill92 answered 5 months ago

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You have recently been hired by Bio Lux Company, in its relatively new treasury management department....

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