Ace Repair Inc. - Cost of Capital

Case #54

Ace Repair, Inc. – Cost of Capital

Summary of Case

Peter Vanderhein was taking an entrepreneurship class at a university in 1978 and during his studies realized the inefficiency in the way that auto repair shops dealt with inventories and receivables but yet still seemed to remain profitable. He felt that if he could purchase and consolidate some shops, install a computer system that would help to manage finances and inventory and train the employees to be the best, he would see an increase in profitability.

In 1981, after his expectations had been exceeded, Peter started looking for more acquisitions and would move some of the already trained employees to the new locations to work and train the new workers under the company guidelines. By 1995, Ace Repair owned 243 shops in the Midwest.

With the increase in business there was also an increase in the financial responsibility. Because of the competition with other repair shops (i.e. large corporations, dealerships), Peter needed to find a way to ensure his success in the business and decided to create a financial group to meet his needs.

Peter hired Adam Naranjo to be the vice president and chief financial officer for his company. Naranjo has gone over the books and feels that overall they have been using the proper procedures for their financials but he is questioning the estimate of the cost of capital.

Adam has hired our consulting firm to do a cost of capital analysis and to evaluate their current estimation procedures. He would also like to get our input on the weights that should be used and the differences in the calculation for WACC.

Question 1

a. Discuss the specific items of capital that should be included in the WACC.

Response:

WACC is used primarily for long-term capital investment decisions; therefore the items to be included should be long-term debt, preferred stock and common stock.

b. The controller currently finds the weights for the weighted average cost...