Ace Case

Ace Repair Inc.

Cost of Capital

Executive Summary

Peter Vanderhein started Ace Repair Inc. in 1979. Based on the financial statements given, we were able to critique Ace’s procedure for estimating the cost of debt and equity, and then make an analysis for Ace’s component cost of capital, WACC, and marginal cost of capital.

The weight of the long term debt was 30.98%. The weight of preferred stock was 7.74%. The weight of common equity was 61.41%. If we focused on the market values, the weight of debt should be 19.44%, the weight of preferred stock should be 4.22%, and the weight of common equity should be 76.34%. Ace’s current method for estimating before-tax cost of debt should change to an after tax-basis in order to be more beneficial for stockholders and their earnings yield should be higher than their WACC. The best estimate of Ace Repair’s cost of debit is 8.3%. The flotation costs should not be included in the cost of debt calculation. The nominal cost of debt should be used rather than the effective annual rate. The estimate of the cost of debt based on the yield to maturity of Ace’s debt is valid if the firm plans to issue more long term debt. The cost of the preferred stock is 7.80%. The after tax yield on preferred stock would be higher than the after-tax yield on debt issues. The cost of retained earnings is 14.37% and the growth rate is 17.75%. Using the bond-yield-plus-risk-premium method to estimate Ace’s cost of retained earnings, we found that the cost of retained earnings was 12.3%. The best estimate for the cost of retained earnings is 15.93%. Our estimate of Ace’s cost of new common stock is 18.5%. The WACC is 10.65%. We concluded then that the WACC should be used for all projects.

Case Analysis

In order to calculate WACC, you need to know the long term debt, preferred stock, and common stock. In order to find all the weights for the book value, you took the value for long term debt, 40,000, preferred stock, 10,000, and common...