Question

Review the capital structure of Starbucks. What is its leverage like? It is important to understand the leverage in the capital structure because it impacts the company’s cost of capital. Please describe the technique for calculating a firm’s cost of equity and the firm’s cost of debt. Please try to make those calculations. Once you’ve done that please defined the weighted average cost of capital is and calculate it.

Answer 1

Answer:

Cost of Capital- Cost of capital is the minimum required return to take a capital budgeting decision. This is used to know whether a project is worth or not.

Weighted average cost of capital- It is the average cost of the capital in which each category of capital is weighted proportionately.

Calculating cost of equity capital with the help of Capital Asset pricing model:

Re = Rf + Beta (Rm-Rf)

Where Re is cost of equity, Beta is the measure of volatility or systematic risk, Rf is risk free rate, Rm is market return.

Example: Risk free return is 4%, Beta is 1.5, Market return is 10% then the cost of equity:

Re = .04+1.5 (.10-.04)

Re = 13%

Calculating Cost of debt (Rd) = Interest expenses - Tax rate,

It can also be calculated by taking Yield to maturity (YTM) into consideration.

YTM = C + [(F-P) /n] / (F+P)/2

Where C is coupon interest, F is Face value, P is price of bond, n is number of periods.

Example: Coupon rate is 5%, Face value is $1000, Price is 1015, n is 10 years then YTM is:

YTM (Rd)= 4.81%

In calculating WACC after tax cost of debt is taken so after tax cost of debt = Rd * (1-Tax rate)

WACC = [Cost of equity * % of equity] + [Cost of debt (1-Tax rate) * % of debt]