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Case 3 – Cost of Capital [Chapter 12]
The Cost of Capital for Master Tools
You have recently been hired by Master Tools (MT) in its relatively new treasury management department. MT was founded eight years ago by Martha Masters. Martha found a method to streamline the manufacturing process, resulting in a cheaper tool. The tools manufactured by MT are designed for the mass market and sold primarily through retail. The company is privately owned by Martha and her family, and it had sales of $97 million last year.
MT primarily sells to do-it-yourself (DIY) customers who use the tools for personal projects, although it does sell through various online marketplaces. As a result, the company’s sales are price sensitive. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Martha has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Martha would like you to perform the analysis. Because the company is privately owned, it is difficult to determine the cost of equity for the company.
Martha wants you to use the pure play approach to estimate the cost of capital for MT, and she has chosen Snap-On Incorporated as a representative company. The following questions will lead you through the steps to calculate this estimate.