FIN 330 Module 4 Project One Example

Memorandum

To: Chief Financial Officer

From: Financial Analyst, Corporate Finance

Date: November 3, 2026

Re: Estimated weighted average cost of capital and the rate for the propane line

Purpose

You asked for an estimate of our weighted average cost of capital before the board reviews the propane-refrigerant product line in December. The rate determines whether the project's expected cash flows create value, so small changes matter: on a $73 million project, a one-point difference in the rate can move net present value by several million dollars. This memo estimates each component from current market data, explains the choices behind them, gives a company-wide WACC of 9.7 percent and recommends how to treat the propane line's additional risk.

Cost of Equity

Graham and Harvey (2001) surveyed chief financial officers and found that about three in four rely on the CAPM for equity costs, and it is our primary method. For the risk-free rate I took the 4.3 percent yield on the 10-year Treasury as of October 30, matching the roughly ten-year life of our projects. Our beta, estimated from five years of monthly returns against the S&P 500, is 1.18; the median of three foodservice equipment peers is 1.12, so ours is in a reasonable range. For the market risk premium I use 5.5 percent, within the range of 5 to 6 percent most practitioners apply. Multiplying beta by the premium gives 6.49 points, and adding the Treasury yield puts the cost of equity at 10.79 percent.

The CAPM fits the data imperfectly (Fama & French, 2004), so I checked the result with the dividend-growth approach. Next year's dividend of $1.26 divided by the $40 price is a 3.2 percent yield; adding growth of 7.3 to 8.0 percent, the range analysts project for earnings over five years, gives 10.5 to 11.2 percent. The two methods agree closely, which supports using 10.8 percent.

Cost of Debt

Our $210 million of 5.25 percent notes trade at $957.82 per $1,000, a yield to maturity of 6.1 percent. That yield, not the coupon, is what new lenders would require today. Interest is tax deductible at the 25 percent rate we pay across federal and state taxes, so borrowing really costs us 6.1 × (1 minus 0.25) = 4.58 percent. Our undrawn revolving credit line would price slightly higher, but it is not part of our permanent financing.

Weights

Weights should reflect what investors' claims are worth today. Equity is 24 million shares at $40, or $960 million. Debt is $210 million of face value at 95.78 percent of par, or about $201 million. Total capital is $1,161 million: 82.7 percent equity and 17.3 percent debt. Book values would give 62 percent equity, because shareholders' equity on the balance sheet is only $340 million, and would understate the cost of capital.

WACC calculation

Result

The company's WACC is about 9.7 percent. Given the uncertainty in beta and the market risk premium, a reasonable range is roughly 9.2 to 10.3 percent. This is the rate our existing business must earn to satisfy investors, and it is the right rate for projects that resemble our current operations in risk.

The Propane Line

The propane line is not an average project. It uses a new refrigerant that requires different components and safety certifications, sells into bars and cafés where we have little presence and depends on how quickly customers replace older machines. Koller et al. (2020) recommend adjusting for such differences through the discount rate only when the risk is systematic and otherwise through the cash flow forecasts. Some of this risk is tied to the economy, since bar and restaurant spending falls in recessions, so a modestly higher rate is justified. I recommend evaluating the line at 9.7 percent and at 11 percent and treating the project as attractive only if it creates value at the higher rate or if scenario analysis shows the downside is limited.

Sensitivity

The two inputs with the most uncertainty are beta and the market risk premium. Each 0.1 change in beta moves the cost of equity by 0.55 points and the WACC by about 0.45 points. Using the peer median beta of 1.12 instead of ours would lower the WACC to about 9.4 percent; a market risk premium of 6 percent would raise it to about 10.2 percent. These ranges are why the result is reported as 9.7 percent with a band, and why the board should see the project evaluated at more than one rate.

Limitations

The estimate assumes our capital structure stays near today's mix. If we fund the propane line with new debt, as Module Six will discuss, the weights and possibly the cost of equity will change. Flotation costs are excluded because the line can be funded without issuing new stock. I will update the inputs before the board meeting if Treasury yields or our share price move materially.

Recommendation

Use 9.7 percent as the company-wide hurdle rate and 11 percent as a stress test for the propane line. I will apply both in the capital budgeting analysis due next week.

References

Fama, E. F., & French, K. R. (2004). The capital asset pricing model: Theory and evidence. Journal of Economic Perspectives, 18(3), 25-46. https://doi.org/10.1257/0895330042162430

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7

Koller, T., Goedhart, M., & Wessels, D. (2020). Valuation: Measuring and managing the value of companies (7th ed.). Wiley.