Moonshine Case
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Comprehensive Introductory ProblemMoonshine Holdings, Inc. intends to invest in two new operating divisions, a beer division and a sour mash distributorship division. While Moonshine is a publicly traded holding company, it does not possess an Equity Beta for either of its intended divisions. However, on the other hand, a number of “proxies” do exist in each industry, thus permitting Moonshine to establish a “proxy” beta for each of their two new operating divisions, that is representative of only the “operating characteristics” of each of the divisions. However, the degree of leverage for each of the industry proxies are significantly different from each other and from Moonshine’s target leverage for the two divisions.BEER DISTRIBUTORSHIP INDUSTRY Company Equity Beta Mkt % of Debt/Value Mkt Capitalization as % of the Industry A 0.13 21% 18% B 0.64 58% 12% C 1.00 65% 47% D 1.08 79% 23%Moonshine wishes to target a market-based “Debt/Value” ratio of 74% for their beer distributorship division, representative of principally long-term debt, the cost of the long-term debt for this division, estimated at 10.05%.
SOUR MASH DISTRIBUTORSHIP INDUSTRY Company Equity Beta Mkt % of Debt/Value Mkt Capitalization as % of the Industry A 0.75 26% 5% B 0.60 4% 8% C 0.88 58% 23% D 1.46 79% 37% E 0.38 14% 5% F 0.95 65% 22%For the sour mash division, Moonshine wishes to target a market-based “Debt/Value” ratio of 42%, again principally representative of long-term debt, the cost of the long-term debt for this division, is estimated at 10.52%. A) Assuming a corporate tax rate of 35%, a long-term risk-free rate of 8.95%, an historical equity risk premium (or excess market return) of 7.43%, calculate Moonshine’s weighted after-tax cost of capital for each of the divisions, as well as an overall corporate, composite weighted after-tax cost of capital, on the basis that the working assets of the beer distributorship division representing 45% of the total working/identifiable assets of the two divisions.