Currently, Lowe\'s Inc. has debt of $16.995 billion, equity of $5.862 billion wi

Question

Currently, Lowe's Inc. has debt of $16.995 billion, equity of $5.862 billion with no preferred stock. If Lowe's has a beta of 1.41 and a YTM of 4.05% on their 30 year bonds, what is their WACC? Assume a risk-fre rate of 2.68% and a broad market return of 9.8%.

Lowe's would like to expand their operations into South America. They are evaluating whether to start expansion in either Brazil or Colombia. After preliminary study, they’ve projected the following revenues over a five year period:

Brazil

Year Net Revenue

1- 90,000,000

2- 112,500,000

3- 132,750,000

4- 139,390,000

5- 143,571,700

Colombia

Year Net Revenue

1- 70,000,000

2- 85,000,000

3- 106,250,000

4- 125,380,000

5- 140,420,000

Given the WACC calculated in the previous question, what amount should the company pay for each project?

Explanation / Answer

Solution:- WACC can be calculated as follows:- =Kd*Wd+Ke*We Where, Kd=cost of debt = 4.05% Wd= Weight of debt = 16.995/22.857 Ke= Cost of common stock = 12.7192%( calculated below) We= Weight of common stock = 5.862/22.857 Now, WACC= 4.05%*16.995/22.857+12.7192*5.862/22.857 =6.27334% i.e. 6.27% Hence the WACC= 6.27% Note:- The cost of equity can be calculated using capm model. Required return = Rf+Beta*(Rm-Rf) Where , Rf= risk free rate = 2.68% Beta= 1.41 Rm= Market risk = 9.8% Substituting the values , Required return =2.68%+1.41*(9.8%-2.68%)= 12.7192% Hence as per CAPM model cost of equity = 12.7192% Calculation of maximum amount to be paid. Years Brazil revenue Colombia revenue PV of WACC i.e 6.27334% PV pf cash flow Brazil PV of cash flow Colombia A B C D E=B*D F=C*D 1    90,000,000.00     70,000,000.00 0.9409698    84,687,279.05       65,867,883.70 2 112,500,000.00     85,000,000.00 0.8854241    99,610,211.56       75,261,048.74 3 132,750,000.00 106,000,000.00 0.8331573 110,601,633.15       88,314,675.06 4 139,390,000.00 125,380,000.00 0.7839758 109,278,392.59       98,294,891.05 5 143,571,700.00 140,420,000.00 0.7376976 105,912,493.55    103,587,492.13 Total 510,090,009.90    431,325,990.68 Hence for the Brazil project the company should pay = 510,090,009.90 For Coloumbia project the company should paya= 431,325,990,68 Note:- I have taken full value of WACC not rounded up. Please feel free to ask if you have nay query in the comment section.

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