Weighted Average Cost of Capital
Hewlett-Packard Company or HP is a multinational American information technology corporation headquartered in Palo Alto, California. HP provides products, technologies, software, technical support and solutions to various consumer groups. These consumers include small- and medium-sized businesses (SMBs) and large enterprises, including customers in the government, health and education sectors. HP specializes in developing and manufacturing computing, data storage, and networking hardware, designing software and delivering services. Major product lines include personal computing devices, enterprise, and industry standard servers, related storage devices, networking products, software and a diverse range of printers, and other imaging products. HP markets its products to households, small- to medium-sized businesses and enterprises directly as well as via online distribution, consumer-electronics and office-supply retailers, software partners and major technology vendors. HP also has strong services and consulting business around its products and partner products. In this analysis, we will use multiple resources to determine HP’s weighted-average cost of capital (WACC). Target Capital Structure
The first step in calculating our WACC was to determine the target capital structure. The target structure was determined using market value numbers. Using market value numbers was the most logical method to determine the target capital structure. The following spreadsheet was developed to help determine the target capital structure using market values and HP’s most recent financial statements:
The following notes and assumptions were made when determining target capital structure: 1. The market value of the notes payable is equal to the book value. Most of HP's long term bonds sold at a very slight discount (less than 1%) , so for estimation purposes, the assumption is that the aggregate market value is approximately equal to their aggregate book value. 2. At 12/5/11 the common stock price was $28.12 per share and there are approximately 24 million shares outstanding, for a total market cap of $674.88 million. 3. There are no outstanding shares of preferred stock.
4. When establishing the target capital structure, no distinction is made between common equity raised by issuing stock versus retained earnings. 5. Accounts payable and accruals are not sources of investor-supplied capital, so they are excluded when calculating WACC. 6. 6. We are under the assumption that the firm will eventually replace most notes payable with long-term debt and the cost of the notes payable and long-term debt is approximately the same, hence it will use one rate for all investor supplied debt. Based on the spreadsheet calculations of market value it is determined that HP’s target capital structure employs approximately 70% debt and 30% equity. Preferred stock has no weight as a component in the calculation of the company’s WACC. Cost of Debt
The cost of debt, which is rd (1-t) was determined using various different methods. First, using HP’s financial statements we determined the structure of their current outstanding long-term debt and calculated their historical or embedded rate. Most recently in September 2010, HP issued outstanding new 5 year bonds at 2.125%. Typically HP’s long term debt has ranged from 3-10 years and taking the averages of debt issued in 2009 and beyond, the historical cost of debt was about 2.8%. HP does not currently have any publicly traded debt so it is difficult to find the yield to maturity. Alternatively, we took the company’s interest expense per their most recent financial statements and divided it by their debt (short and long-term). This calculation is (in millions) 505/22,304 = 2.3%. Similar bonds according to Bloomberg.com are trading with a coupon...
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