Question

You have recently been hired by Swan Motors, Inc. (SMI), in its relatively new treasury management department. SMI was founded 8 years ago by Joe Swan. Joe found a method to manufacture a cheaper battery with much greater energy density than was previously possible, giving a car powered by the battery a range of 700 miles before requiring a charge. The cars manufactured by SMI are midsized and carry a price that allows the company to compete with other mainstream auto manufacturers. The company is privately owned by Joe and his family, and it had sales of $97 million last year.

SMI primarily sells to customers who buy the cars online, although it does have a limited number of company-owned dealerships. Most sales are online. The customer selects any customization and makes a deposit of 20 percent of the purchase price. After the order is taken, the car is made to order, typically within 45 days. SMI’s growth to date has come from its profits. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Joe 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 Joe 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. Joe wants you to use the pure play approach to estimate the cost of capital for SMI, and he has chosen Tesla Motors as a representative company.

1. You used Tesla as a representative company to estimate the cost of capital for SMI. What are some of the potential problems with this approach in this situation? What improvements might you suggest?

Answer 1

Answe

Solution)
1) Book Value of Long Term Debt = 9,418,319
Book Value of Equity = 4,237,503
Book Value of Debt = 10,314,868

2) Market Cap = 50.78 Billions
Current Stock Price = 300.37 (market open)
Beta = 0.96
Share Outstanding = 168.922 Millions
Treasury Rate = 1.7%
Ke as per CAPM is as follows
Ke = 1.7% + 0.96(7%) = 8.42%
3) List of competitors
Particulars Beta
Mitsubishi Corp 1.02
Audi AG 0.39
Nissan Motor Co Ltd 1.09
Ford Motor Company 1.05
General Motor 1.64
Honda Motor Co Ltd 1.30
Volkswagen AG(p.DE) 1.53
Volkswagen AG(DE) 1.53
Total = 9.55 Average Beta = 1.19375
CAPM Acc to Industry Average Beta
Ke = 1.7% + 1.19375(7%) = 10.05625%
If we have beta of tesla so why to take average of industry beta this is coz
The weighted average of betas of stocks or businesses in the same industry group. It is a proxy for systematic risk (beta) that is similar for all businesses in a specific industry. This value of beta is typically used in such cases where a given stock or market is less liquid or has a very short history (historical data). Industry betas are also quite instrumental for private companies and business units (whose individual betas are, by nature, hard to be figured out, if any).
4) Tesla has four bond type with yield is as follows
7.00%
-0.450%
-3.15%
-0.561%

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