Finance 100 - Hydrotech Case Study

Topics: Weighted average cost of capital, Finance, Cost of capital Pages: 4 (826 words) Published: January 16, 2011
FIN100 – Week 10
Integrative Case Study
Due – 9/5/10

Case Information:
You work for HydroTech, a large manufacturer of high pressure industrial water pumps. The firm specializes in natural disaster services, ranging from pumps that draw water from lakes, ponds, and streams in drought stricken area to pumps that remove high water volumes in flooded area. You report directly to the CFO. Your boss has asked you to calculate HydroTech’s WAAC in preparation for an executive retreat. Too bad, you are not invited, as water pumps and skiing are on the agenda in Sun Valley, Idaho. At least you have an analyst on hand to gather the following required information:

1. The risk-free rate of interest, in this case, the yield of the ten-year government bond, which is 6%. 2. HydroTech’s:
a. Market Capitalization (its market value of equity), $100 million. b. CAPM beta, 1.2
c. Total book value of debt outstanding, $50 million.
d. Cash, $10 million
3. The cost of debt (using the quoted yields on HydroTech’s outstanding bond issues), which is 7%.

With this information in hand, you are now prepared to undertake the analysis.

Case Questions & Solutions for Case Questions 1 – 5

1. Calculate HydroTech’s net debt.

Total Debt = $50 million; Cash = $10 million

Net debt = Total debt – cash
Net debt = $50 million - $10 million
Net debt = $40 million

HydroTech’s net debt is $40 million

2. Compute HydroTech’s equity and (net) debt weights based on the market value of equity and the book value of net debt.

Market value of equity = 100 million; Book value of net debt = 40 million

Weight of Equity = Market value of equity / (Total firm Value = (Equity + Net Debt)) Weight of Equity = 100/ (100+40)
Weight of Equity = 100 / 140
Weight of Equity = 0.71
Weight of Equity = 71%

Weight of Debt = Net Debt / (Total firm Value = (Equity + Net Debt)) Weight of Debt = 40/ (100+40)
Weight of Debt =...

References: Berk, J., DeMarzo, P., & Harford, J. (2009). FIN100: Fundamentals of corporate
         finance: 2010 custom edition. New York: Prentice Hall.
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