Cyberproblem

The Cost of Capital - AT&T

Capital budgeting involves decisions about whether or not to invest in fixed assets, and it has a major influence on firms' future performance and value. Discounted cash flow analysis is used in capital budgeting, and a key element of this procedure is the discount rate used in the analysis. Capital must be raised to finance fixed assets, and this capital comes from different types of debt, from preferred stock, and from common equity. Each of these capital components has a cost, and these cost rates, along with the target proportions of each, are used to calculate the firm's weighted average cost of capital, WACC. In this cyberproblem, you must obtain information from http://www.att.com, http://www.marketguide.com, and http://www.bloomberg.com to estimate AT&T's WACC.

1. How much interest bearing short-term debt did AT&T have at the end of 2001 and what was the average cost of this debt? (Hint: Access AT&T's 2001 annual report at http://www.att.com/ar-2001, and look at "Note 12. Debt Obligations", found in the Notes to the consolidated financial statements).

2. What was AT&T's actual capital structure at the end of 2001, based on its consolidated balance sheets? What portion of AT&T's capital structure did short-term debt, long-term debt, and stockholders' equity represent in 2001? Short-term debt will be defined as the total debt maturing within one-year, and long-term debt will be the figure given the Consolidated Balance Sheet. Visit http://www.marketguide.com to compare your calculations with Marketguide's listed debt ratio.

3. Now recalculate AT&T's capital structure just using long-term capital, i.e. long-term debt and common equity. Use your results from the previous question to accomplish this. Calculate the long-term debt to total long-term capital ratio and the common equity to total capital ratio.

4. Assume that AT&T wants to issue fixed rate 10-year bonds. If their investment bankers tell the firm that they can do so at a spread (premium) of 1.5% greater than the equivalent maturity Treasury security, what would be AT&T's before-tax cost of this long-term debt? (Hint: Use http://www.bloomberg.com to look at a yield curve of Treasury securities. The "Ask Yield" for the securities can be found in the far left column.)

5. Review AT&T's 2001 Notes to Consolidated Financial Statements. Examine the note on Income Taxes. Use the average tax rate for 2001 listed in this financial note as an estimate of AT&T's relevant marginal tax rate to calculate the after-tax cost of short-term debt and long-term debt (the bonds).

6. Apply the Capital Asset Pricing Model (CAPM) Security Market Line to estimate ks for AT&T. Assume a market risk premium (km - kRF) of 7.0%. Use Ask Yield on a 10-year Treasury bond (found earlier in the problem) as an estimate of the risk-free rate. Obtain a beta estimate for AT&T from http://www.marketguide.com.