{"id":29538,"date":"2022-12-31T18:57:24","date_gmt":"2022-12-31T18:57:24","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=29538"},"modified":"2024-04-10T07:38:27","modified_gmt":"2024-04-10T07:38:27","slug":"capital-structure-and-cost-of-capital-relative-to-peers","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/","title":{"rendered":"Capital Structure and Cost of Capital Relative to Peers"},"content":{"rendered":"<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/0Odnj2PpwSc\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>Jackie Zhao is an analyst at Momentum Capital. She has been tasked with evaluating Marigold\u2019s WACC, a company the management is looking to acquire. Marigold operates in the agriculture sector, manufacturing farm equipment such as tractors and combined harvesters. She gathers information about Marigold and publicly traded agricultural equipment manufacturers presented in Exhibit 1.<\/p>\n<p>$$ \\textbf{Exhibit 1: Information on Marigold and Peer Companies} \\\\ \\begin{array}{l|c|c} &amp; \\textbf{Marigold} &amp; {\\textbf{Agricultural Equipment} \\\\ \\textbf{Manufacturers&#8217; Average} } \\\\ \\hline { \\textbf{Commons Size} \\\\ \\textbf{Balance sheet} } &amp; &amp; \\\\ \\hline \\text{Accounts receivables} &amp; 9\\% &amp; 10\\% \\\\ \\hline \\text{Inventory} &amp; 5\\% &amp; 4\\% \\\\ \\hline \\text{Cash and cash equivalents} &amp; 12\\% &amp; 14\\% \\\\ \\hline \\text{Other current assets} &amp; 6\\% &amp; 5\\% \\\\ \\\\ \\text{PPE (net)} &amp; 24\\% &amp; 26\\% \\\\ \\hline {\\text{Goodwill and} \\\\ \\text{intangible assets}} &amp; 20\\% &amp; 29\\% \\\\ \\hline \\text{Other assets} &amp; 4\\% &amp; 4\\% \\\\ \\\\ \\textbf{Other Information} &amp; &amp; \\\\ \\hline \\text{Debt (millions)} &amp; 20.4 &amp; 312 \\\\ \\hline \\text{Assets (millions)} &amp; 100 &amp; 1376 \\\\ \\hline \\text{EBITDA (millions)} &amp; 9.6 &amp; 104 \\\\ \\hline \\text{Marginal tax rate} &amp; 20\\% &amp; 22\\% \\\\ \\hline \\text{Interest expense (millions)} &amp; 1.3 &amp; 24 \\\\ \\hline \\text{Beta} &amp; N\/A &amp; 1.36 \\end{array} $$<\/p>\n<p><em><strong>Notes:<\/strong><\/em><\/p>\n<ul>\n<li>40% of the company\u2019s revenue comes from spare part sales, and 6 customers in the same geographic location contribute 60% of revenues.<\/li>\n<li>The company is family-owned, with the founder heavily involved in its operations.<\/li>\n<\/ul>\n<p>Zhao relies on an internally developed synthetic bond yield schedule to estimate the company\u2019s cost of debt.<\/p>\n<p>$$ \\textbf{Exhibit 2: Synthetic Credit Rating Schedule} \\\\ \\begin{array}{c|c|c|c} \\textbf{Credit Rating} &amp; \\textbf{Credit Spread} &amp; \\textbf{IC} &amp; \\textbf{D\/E} \\\\ \\hline AAA &amp; 0.7\\% &amp; IC &gt; 10\\text{times} &amp; D\/E &lt; 15\\% \\\\ \\hline AA &amp; 1.2\\% &amp; 9 &lt; IC &lt; 10 &amp; 15\\% &lt; D\/E &lt; 20\\% \\\\ \\hline A &amp; 1.5\\% &amp; 7 &lt; IC &lt; 9 &amp; 20\\% &lt; D\/E &lt; 25\\% \\\\ \\hline BBB &amp; 2.2\\% &amp; 5 &lt; IC &lt; 7 &amp; 25\\% &lt; D\/E &lt; 30\\% \\\\ \\hline BB &amp; 3\\% &amp; 4 &lt; IC &lt; 1.6 &amp; 30\\% &lt; D\/E &lt; 40\\% \\end{array} $$<\/p>\n<p>The YTM on a 10-year benchmark government bond for emerging market countries is 6%. Zhao estimates Marigold\u2019s cost of debt by estimating a synthetic bond yield on the company\u2019s 10-year non-traded bonds. Further, she uses the build-up approach and CAPM to estimate Marigold&#8217;s equity cost. Finally, Zhao assigns the following risk premiums<\/p>\n<ul>\n<li>Size premium (SP): 7%.<\/li>\n<li>Equity risk premium (ERP): 5%.<\/li>\n<li>Industry premium (IP): 1%.<\/li>\n<li>Specific-company risk premium (SCRP): 6%.<\/li>\n<li>Country risk premium (CRP): 2%.<\/li>\n<\/ul>\n<p>To estimate Marigold\u2019s WACC, Zhao assumes Marigold\u2019s current capital structure is its target capital structure.<\/p>\n<blockquote>\n<h2>Question<\/h2>\n<p>From the case above, Marigold\u2019s cost of equity, using the expanded CAPM, is <em>closest to<\/em>:<\/p>\n<ol type=\"A\">\n<li>27%.<\/li>\n<li>24%.<\/li>\n<li>6%.<\/li>\n<\/ol>\n<h4>Solution<\/h4>\n<p>The correct answer is<strong> A<\/strong>.<\/p>\n<p>$$ \\begin{align*} r_e &amp;=r_f+\\beta_{\\text{peer}}\\left(ERP\\right)+SP+IP+SCRP \\\\ r_e &amp; =6\\%+1.36\\left(5\\%\\right)+7\\%+1\\%+6\\% \\\\ r_e &amp;= 26.8\\% \\approx 27\\% \\end{align*} $$<\/p>\n<p><strong>B is incorrect<\/strong>. It uses the build-up approach.<\/p>\n<p>$$ \\begin{align*} r_e &amp; =r_f+ERP+SP+SCRP \\\\ r_e &amp; =6\\%+5\\%+7\\%+6\\% \\\\ r_e &amp; =24\\% \\end{align*} $$<\/p>\n<p><strong>C is incorrect<\/strong>. This is the risk-free rate.<\/p>\n<\/blockquote>\n<p>Reading 20: Cost of Capital: Advanced Topics<\/p>\n<p><em>LOS 20 (f) Evaluate a company\u2019s capital structure and cost of capital relative to peers.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Jackie Zhao is an analyst at Momentum Capital. She has been tasked with evaluating Marigold\u2019s WACC, a company the management is looking to acquire. Marigold operates in the agriculture sector, manufacturing farm equipment such as tractors and combined harvesters. She&#8230;<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,345],"tags":[],"class_list":["post-29538","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-corporate-finance","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Capital Structure and Cost of Capital Relative to Peers - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"Know the factors involved, such as risk premiums, industry premium, specific-company risk premium, to estimate the cost of equity accurately.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Capital Structure and Cost of Capital Relative to Peers - CFA, FRM, and Actuarial Exams Study Notes\" \/>\n<meta property=\"og:description\" content=\"Know the factors involved, such as risk premiums, industry premium, specific-company risk premium, to estimate the cost of equity accurately.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/\" \/>\n<meta property=\"og:site_name\" content=\"CFA, FRM, and Actuarial Exams Study Notes\" \/>\n<meta property=\"article:published_time\" content=\"2022-12-31T18:57:24+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2024-04-10T07:38:27+00:00\" \/>\n<meta name=\"author\" content=\"Nicolas Joyce\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:label1\" content=\"Written by\" \/>\n\t<meta name=\"twitter:data1\" content=\"Nicolas Joyce\" \/>\n\t<meta name=\"twitter:label2\" content=\"Est. reading time\" \/>\n\t<meta name=\"twitter:data2\" content=\"3 minutes\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\\\/\\\/schema.org\",\"@graph\":[{\"@type\":\"Article\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/corporate-finance\\\/capital-structure-and-cost-of-capital-relative-to-peers\\\/#article\",\"isPartOf\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/corporate-finance\\\/capital-structure-and-cost-of-capital-relative-to-peers\\\/\"},\"author\":{\"name\":\"Nicolas Joyce\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#\\\/schema\\\/person\\\/393e8b0a7757cde1d197fb0c060af25f\"},\"headline\":\"Capital Structure and Cost of Capital Relative to Peers\",\"datePublished\":\"2022-12-31T18:57:24+00:00\",\"dateModified\":\"2024-04-10T07:38:27+00:00\",\"mainEntityOfPage\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/corporate-finance\\\/capital-structure-and-cost-of-capital-relative-to-peers\\\/\"},\"wordCount\":520,\"articleSection\":[\"CFA Level II Study Notes\",\"Corporate Finance\"],\"inLanguage\":\"en-US\"},{\"@type\":\"WebPage\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/corporate-finance\\\/capital-structure-and-cost-of-capital-relative-to-peers\\\/\",\"url\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/corporate-finance\\\/capital-structure-and-cost-of-capital-relative-to-peers\\\/\",\"name\":\"Capital Structure and Cost of Capital Relative to Peers - CFA, FRM, and Actuarial Exams Study Notes\",\"isPartOf\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#website\"},\"datePublished\":\"2022-12-31T18:57:24+00:00\",\"dateModified\":\"2024-04-10T07:38:27+00:00\",\"author\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#\\\/schema\\\/person\\\/393e8b0a7757cde1d197fb0c060af25f\"},\"description\":\"Know the factors involved, such as risk premiums, industry premium, specific-company risk premium, to estimate the cost of equity accurately.\",\"breadcrumb\":{\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/corporate-finance\\\/capital-structure-and-cost-of-capital-relative-to-peers\\\/#breadcrumb\"},\"inLanguage\":\"en-US\",\"potentialAction\":[{\"@type\":\"ReadAction\",\"target\":[\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/corporate-finance\\\/capital-structure-and-cost-of-capital-relative-to-peers\\\/\"]}]},{\"@type\":\"BreadcrumbList\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/corporate-finance\\\/capital-structure-and-cost-of-capital-relative-to-peers\\\/#breadcrumb\",\"itemListElement\":[{\"@type\":\"ListItem\",\"position\":1,\"name\":\"Home\",\"item\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/\"},{\"@type\":\"ListItem\",\"position\":2,\"name\":\"Capital Structure and Cost of Capital Relative to Peers\"}]},{\"@type\":\"WebSite\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#website\",\"url\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/\",\"name\":\"CFA, FRM, and Actuarial Exams Study Notes\",\"description\":\"Question Bank and Study Notes for the CFA, FRM, and Actuarial exams\",\"potentialAction\":[{\"@type\":\"SearchAction\",\"target\":{\"@type\":\"EntryPoint\",\"urlTemplate\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/?s={search_term_string}\"},\"query-input\":{\"@type\":\"PropertyValueSpecification\",\"valueRequired\":true,\"valueName\":\"search_term_string\"}}],\"inLanguage\":\"en-US\"},{\"@type\":\"Person\",\"@id\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/#\\\/schema\\\/person\\\/393e8b0a7757cde1d197fb0c060af25f\",\"name\":\"Nicolas Joyce\",\"image\":{\"@type\":\"ImageObject\",\"inLanguage\":\"en-US\",\"@id\":\"https:\\\/\\\/secure.gravatar.com\\\/avatar\\\/684508c19e959bb01da12a9dc741428f559e4e5df43fc41ed68efa7f2d3b2b9d?s=96&d=mm&r=g\",\"url\":\"https:\\\/\\\/secure.gravatar.com\\\/avatar\\\/684508c19e959bb01da12a9dc741428f559e4e5df43fc41ed68efa7f2d3b2b9d?s=96&d=mm&r=g\",\"contentUrl\":\"https:\\\/\\\/secure.gravatar.com\\\/avatar\\\/684508c19e959bb01da12a9dc741428f559e4e5df43fc41ed68efa7f2d3b2b9d?s=96&d=mm&r=g\",\"caption\":\"Nicolas Joyce\"},\"url\":\"https:\\\/\\\/analystprep.com\\\/study-notes\\\/author\\\/kajal\\\/\"}]}<\/script>\n<meta property=\"og:video\" content=\"https:\/\/www.youtube.com\/embed\/0Odnj2PpwSc\" \/>\n<meta property=\"og:video:type\" content=\"text\/html\" \/>\n<meta property=\"og:video:duration\" content=\"3649\" \/>\n<meta property=\"og:video:width\" content=\"480\" \/>\n<meta property=\"og:video:height\" content=\"270\" \/>\n<meta property=\"ya:ovs:adult\" content=\"false\" \/>\n<meta property=\"ya:ovs:upload_date\" content=\"2022-12-31T18:57:24+00:00\" \/>\n<meta property=\"ya:ovs:allow_embed\" content=\"true\" \/>\n<!-- \/ Yoast SEO plugin. -->","yoast_head_json":{"title":"Capital Structure and Cost of Capital Relative to Peers - CFA, FRM, and Actuarial Exams Study Notes","description":"Know the factors involved, such as risk premiums, industry premium, specific-company risk premium, to estimate the cost of equity accurately.","robots":{"index":"index","follow":"follow","max-snippet":"max-snippet:-1","max-image-preview":"max-image-preview:large","max-video-preview":"max-video-preview:-1"},"canonical":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/","og_locale":"en_US","og_type":"article","og_title":"Capital Structure and Cost of Capital Relative to Peers - CFA, FRM, and Actuarial Exams Study Notes","og_description":"Know the factors involved, such as risk premiums, industry premium, specific-company risk premium, to estimate the cost of equity accurately.","og_url":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/","og_site_name":"CFA, FRM, and Actuarial Exams Study Notes","article_published_time":"2022-12-31T18:57:24+00:00","article_modified_time":"2024-04-10T07:38:27+00:00","author":"Nicolas Joyce","twitter_card":"summary_large_image","twitter_misc":{"Written by":"Nicolas Joyce","Est. reading time":"3 minutes"},"schema":{"@context":"https:\/\/schema.org","@graph":[{"@type":"Article","@id":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/#article","isPartOf":{"@id":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/"},"author":{"name":"Nicolas Joyce","@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/393e8b0a7757cde1d197fb0c060af25f"},"headline":"Capital Structure and Cost of Capital Relative to Peers","datePublished":"2022-12-31T18:57:24+00:00","dateModified":"2024-04-10T07:38:27+00:00","mainEntityOfPage":{"@id":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/"},"wordCount":520,"articleSection":["CFA Level II Study Notes","Corporate Finance"],"inLanguage":"en-US"},{"@type":"WebPage","@id":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/","url":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/","name":"Capital Structure and Cost of Capital Relative to Peers - CFA, FRM, and Actuarial Exams Study Notes","isPartOf":{"@id":"https:\/\/analystprep.com\/study-notes\/#website"},"datePublished":"2022-12-31T18:57:24+00:00","dateModified":"2024-04-10T07:38:27+00:00","author":{"@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/393e8b0a7757cde1d197fb0c060af25f"},"description":"Know the factors involved, such as risk premiums, industry premium, specific-company risk premium, to estimate the cost of equity accurately.","breadcrumb":{"@id":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/#breadcrumb"},"inLanguage":"en-US","potentialAction":[{"@type":"ReadAction","target":["https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/"]}]},{"@type":"BreadcrumbList","@id":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/capital-structure-and-cost-of-capital-relative-to-peers\/#breadcrumb","itemListElement":[{"@type":"ListItem","position":1,"name":"Home","item":"https:\/\/analystprep.com\/study-notes\/"},{"@type":"ListItem","position":2,"name":"Capital Structure and Cost of Capital Relative to Peers"}]},{"@type":"WebSite","@id":"https:\/\/analystprep.com\/study-notes\/#website","url":"https:\/\/analystprep.com\/study-notes\/","name":"CFA, FRM, and Actuarial Exams Study Notes","description":"Question Bank and Study Notes for the CFA, FRM, and Actuarial exams","potentialAction":[{"@type":"SearchAction","target":{"@type":"EntryPoint","urlTemplate":"https:\/\/analystprep.com\/study-notes\/?s={search_term_string}"},"query-input":{"@type":"PropertyValueSpecification","valueRequired":true,"valueName":"search_term_string"}}],"inLanguage":"en-US"},{"@type":"Person","@id":"https:\/\/analystprep.com\/study-notes\/#\/schema\/person\/393e8b0a7757cde1d197fb0c060af25f","name":"Nicolas Joyce","image":{"@type":"ImageObject","inLanguage":"en-US","@id":"https:\/\/secure.gravatar.com\/avatar\/684508c19e959bb01da12a9dc741428f559e4e5df43fc41ed68efa7f2d3b2b9d?s=96&d=mm&r=g","url":"https:\/\/secure.gravatar.com\/avatar\/684508c19e959bb01da12a9dc741428f559e4e5df43fc41ed68efa7f2d3b2b9d?s=96&d=mm&r=g","contentUrl":"https:\/\/secure.gravatar.com\/avatar\/684508c19e959bb01da12a9dc741428f559e4e5df43fc41ed68efa7f2d3b2b9d?s=96&d=mm&r=g","caption":"Nicolas Joyce"},"url":"https:\/\/analystprep.com\/study-notes\/author\/kajal\/"}]},"og_video":"https:\/\/www.youtube.com\/embed\/0Odnj2PpwSc","og_video_type":"text\/html","og_video_duration":"3649","og_video_width":"480","og_video_height":"270","ya_ovs_adult":"false","ya_ovs_upload_date":"2022-12-31T18:57:24+00:00","ya_ovs_allow_embed":"true"},"_links":{"self":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/29538","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/comments?post=29538"}],"version-history":[{"count":16,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/29538\/revisions"}],"predecessor-version":[{"id":37821,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/posts\/29538\/revisions\/37821"}],"wp:attachment":[{"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/media?parent=29538"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/categories?post=29538"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/analystprep.com\/study-notes\/wp-json\/wp\/v2\/tags?post=29538"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}