By: Michael Malone
Statement of the Problem
Rajat Singh, a managing director at Hudson Bancorp, needs to find a way to rejuvenate the paper check corporation. One main part that needs to be calculated is the appropriate mixture of debt and equity for the firm. The company needs to determine the correct mixture so that they can both minimize the cost of capital and increase the shareholders value. I will analyze the current and future situation of the company, trying to find the correct credit rating to use that will increase income. With the new credit rating, I will be able to recommend a certain amount of debt for the company to take on and be profitable. Facts and Assumptions
When trying to accurately calculate the cost of capital, the one main method stands out the most. I had to calculate the WACC of the firm for the various credit ratings. In order to accurately calculate this, I had to incorporate the repurchase of shares and add the newfound debt to the total debt from 2001. The project debt used by the corporation didn’t factor in the repurchase of shares and therefore it was calculated wrong.
To help me solve the equation for the best WACC, I had to make some basic assumptions about the case. For starters, as shown in case, I decided to use a 37% tax rate like the analysts for Bancorp did because I felt that it would be comparable to the numbers that they calculated in the projection. Next, I decided to use the 5-year note yield because analysts provided information to show that the market would mature after 5 years and paper checks would be nonexistent.
Furthermore, I had to use the CAPM equation to figure out what my numbers would be for the WACC equation. To show this, I used the equation: CAPM = Rf + (Rm-Rf) β
Through the use of the case, I was able to assume a risk free rate of 3.45% while I used 11.03% for the market risk premium and 0.85 and the beta. This led us to the calculation of the cost of equity, which we could then...