Advance Auto Parts Inc (AAP)
You can do this project on your own or work together in teams of 2 students. Please include students names in worksheet if working on a team.
Part 1: AAP’s Weighted Cost of Capital
You work in AAP Inc´s corporate finance and treasury department and have been assigned to the team estimating AAP´s WACC. You must estimate this WACC in preparation for a team meeting later today. You quickly realize that the information you need is readily available online.
1. You will first have to download into excel AAP’s Financial Statements for the past 2 fiscal years. Go to SEC EDGAR Company Search and use the option to the right using AAP’s Ticker “AAP” to look for the information. Remember to use the 10Ks (these have the annual reports)
2. Go tohttp://finance.yahoo.com. Under “Market Data” you will find the yield to maturity for 10-year Treasury bonds listed as “10 Yr Bond(%).” Collect this number as your risk-free rate.
3. Still in Yahoo Finance, in the box next in the search bar, type AAP’s ticker symbol AAP), and click “Search.” Once you see the basic information for AAP, find the current stock price and click “Key Statistics” on the left side of the screen. Collect AAP’s number of shares outstanding and beta. (You can also find the number of shares outstanding in the financial statements that you downloaded in step 1)
4. Calculate AAP’s cost of equity capital using the CAPM, the risk-free rate you collected in step 2, and a market risk premium of 10%.
5. To get AAP’s cost of debt and the market value of its long-term debt, you will need the price and yield to maturity on the firm’s existing long-term bonds. Go to
http://finramarkets.morningstar.com/BondCenter/Default.jsp?,
click “Search,” click “Corporate,” type AAP ticker “Show Results.” A list of AAP’s outstanding bond issues will appear.
Assume that APP’s policy is to use the yield to maturity of its 10 year obligations as its cost of debt (or closest maturity). Find the bond issue that is as close to 10 years from maturity as possible. (Hint: Would typically not select a callable bond, but in this case it is the one with the longest maturity….)
Find the yield to maturity for your chosen bond issue (it is in the column titled “Yield”) and enter that yield as your pretax cost of debt into your spreadsheet.
Next, copy and paste the data in the entire table of info listed for AAP the FINRA web pages into Excel . [For a quick way to do this, refer to Appendix 1]
6. You now have the price for each bond issue, but you need to know the size of the issue. Returning to the Web page, go to the row of the bond you chose and click the Issuer Name in the first column. This brings up a Web page with all of the informationabout the bond issue. Scroll down until you find “Amount Outstanding” on the right side. Noting that this amount is quoted in thousands of dollars(e.g. $60,000 means 60 million) record the issue amount in the appropriate row of your spreadsheet. Repeat this step for all of the bond issues.
7. The price for each bond issue in your spreadsheet is reported as a percentage of the bond’s par value. For example, 104.50 means that the bond issue is trading at 104.5% of its par value. You can calculate the market value of each bond issue by multiplying the amount outstanding by Price /100. Do so for each issue (listed on the first 2 pages of bonds) and then calculate the total of all the bond issues. This is the market value of AAP’s debt.
8. Compute the weights for AAP’s equity and debt based on the market value of equity (Market Capitalization) and AAP’s market value of debt, computed in step 5.
9. Assuming that AAP has a tax rate of 20%, calculate its effective cost of debt capital.
10. Calculate AAP’s WACC.
11. Calculate AAP’s net debt by subtracting its cash (collected in step 2) from its debt. Recalculate the weights for the WACC using the market value of equity, net debt, and enterprise value. Recalculate AAP’s WACC using the weights based on the net debt. How much does it change?
12. How confident are you of your estimate? Which implicit assumptions did you make during your data collection efforts?
13. Looking at the yields of all the AAP bonds outstanding, How would have the WACC changed if you had calculated the cost of debt using the information for all the bonds outstanding instead of just using the 5 year bond (Do an estimate. Don’t recalculate)
Part 2. New Stores
Your next assignment is to determine if AAP should invest in a new stores so you need to determine net cash flows and NPV and determine if the project is viable or not.
Capital expenditures to produce the new stores will initially require an investment of $1.8 billion. Other development costs that will be required to finish the stores project is $900 million this year. Any ongoing costs for upgrades will be covered in the margin calculation below. The store project is expected to have a life of five years. First-year revenues for the new ride are expected to be $3,400,000,000 ($3,400 million). The ride revenues are expected to grow by 37% for the second year, and then increase by 5% for the third, decrease by 15% for the 4th and finally decrease by 25% for the 5th (final) year of operation. Your job is to determine the rest of the cash flows associated with this project. Your boss has indicated that the operating costs and net working capital requirements are similar to the rest of the company’s products. Since your boss hasn’t been much help, here are some tips to guide your analysis:
1. You will need to use the Financial Statements that you downloaded in Part 1.
2. You are now ready to determine the free cash flow. Compute the free cash flow based on the information above for each year using:
Free Cash Flow = (Revenues – Costs- Depreciation) x(1- Tax Rate) + Depreciation – Capex – Change in NWC
Set up the timeline and computation of the free cash flow in separate, contiguous columns for each year of the project life. Be sure to make outflows negative and inflows positive.
a. Assume that the project’s profitability will be similar to AAP’s existing projects and estimate costs for each year of your project by using the average ratio of non-depreciation costs to revenue for the last 2 fiscal years (in practice you really tend to use at least 4 years worth of data, but for this exercise 2 years will suffice):
(Costs of Goods Sold* + SG&A)/Sales
*AAP calls cost of goods sold, cost of sales
You should assume that this ratio will hold for this project as well. You do not need to break out the individual components of operating costs in your forecast.
Simply the forecast to the Total Cost of Goods Sold (or cost of revenue) + SG&A +R&D for each year.
Determine AAP’s tax rate as 1- (Income After Tax/Income Before Tax) in the last fiscal year reported. Recalculate the WACC form Part 1 using this tax rate. What should you use if this number is negative?
Calculate the net working capital required each year by assuming that the level of NWC will be a constant percentage of the project’s sales. Use AAP’s last 2 fiscal year average NWC/Sales to estimate the required percentage. (Use only accounts receivable, accounts payable, and inventory to measure working capital. Other components of current assets and liabilities are harder to interpret and are not necessarily reflective of the project’s required NWC—e.g., AAP’s cash holdings.)
To determine the free cash flow, calculate theadditionalcapital investment and thechangein net working capital each year.
Determine the NPV of the project with WACC calculated in Part 1 step 10 and the projects IRR
For the NPV calculation remember to add the first CF when you are using the excel function =NPV(rate, CF1:CF5) + CF0
For the IRR include all cash flows in your excel calculation.
Should AAP invest in the project?