So, now, hands on on calculating the cost of capital.
As you see, once you understand the concepts, it's not that difficult.
We're going to look at,
well, there's a couple of simplifications here, but more or less,
this is exactly what you have to do to calculate any company's cost of capital.
We're going to look at a popular one.
And we're going to look at a Starbucks,
a company which I actually do spend a lot of time.
Maybe you do, too.
and, and this company is popular, everybody knows it.
And we're going to look at this company at a particular point in time.
And that is in the third quarter, the end of the third quarter.
Of 2013, and at that particular point in time, question number
one is how was this company financing its investment activities?
And the company was mostly using debt and equity.
The debt of the company was given by a bond.
And that bond was actually four years away from maturity.
Again, remember as we discussed before that doesn't mean that it's a four year
bond, it might have been a ten year bond that, you know, six years have gone by.
And it's only four years away from maturity.
Either one or the other it's kind of irrelevant for us.
What matters is that that particular bond is four years away from maturity.
When we look at the book value what the company has in
it's books about this bond it's 449.7 million dollars.
Almost 550 million dollars.
But remember.
That each thing that the company, each debt, piece of debt or equity that
the company has in its books at a specific value, it may have a completely different
market value, completely or similar or they may, but it may have a different.
A market value.
More likely than not it will have a different market value and
that is the case with Starbucks.
Starbucks actually has a market value.
The bonds of Starbucks have a market value, 629.4 million.
So we have roughly 550 book value and 629 million of market value.
So as we said before there's a difference in this case between the market value and
the book value.
That difference comes together with a difference between the interest rate and
the yield to maturity.
In the case of the four year bonds that Starbucks had at that particular point in
time, the interest rate was 6.25%, but the yield to maturity was only 2.3%.
Now, just a quick reflection on that.
That basically means that when Starbucks issued that bond,
the market was actually requiring a much higher return than they're issuing now.
When you issue a bond, you typically put an interest rate or coupon that is more or
less what you think that the market will require at that point in time.
In other words when Starbucks issued this particular bond the Starbucks thought that
the market would require more or less 6.25%.
But maybe the company got less risky over time, or
the sector got less risky over time, or the economy got less risky over time.
It doesn't really matter for our purposes.
The only thing that matters is that.
If Starbucks were to issue a bond today, instead of issuing that with a coupon
of 6.25% they could get away with issuing a bond with a coupon of 2.3%.
Of course, we're talking about a bond that would be similar to the one that is
outstanding and that that's not increased very substantially the amount of debt.
If you obviously want to triple, or multiply by a large factor, the amount of
debt, well, the amount is going to charge you more because the more debt,
the riskier you become.
But if Starbucks were to issue a similar bond in a reasonable amount
then they would have to pay 2.3% today, which again that's another way of
thinking why the yield to maturity is the proper cost of debt.
Because it's showing me not what the market was requiring some time ago when we
issued the bond but what the market is requiring today.
So between that yield to maturity of 2.3% and the interest rate of 2.,
6.25 the relevant number for us is that yield to maturity of 2.3%.