2. Introduction
The purpose of this project is to analyze if General Motors (GM) should finance a
new one million dollar building.
The analysis will include cost of debt, cost of preferred stock, cost of common
equity, capital structure, and the weighted average cost of capital (WACC)
definitions and calculations.
An overview of GMs business model, potential risks, and strategies for success
are discussed.
Other finance calculations that are used in determining if GM should go through
with the project include gross profit margin and IRR calculations.
3. About General Motors
GM was founded in 1908 and its headquarters is Detroit, Michigan (General Motors, 2015).
General Motors Mission Statement: "G.M. is a multinational corporation engaged in socially responsible
operations, worldwide. It is dedicated to provide products and services of such quality that our customers
will receive superior value while our employees and business partners will share in our success and our
stock-holders will receive a sustained superior return on their investment" (Redlac.org, n.d., para 1).
General Motors Vision Statement: "Over the past 100 years, GM has been a leader in the global automotive
industry. And the next 100 years will be no different. GM is committed to leading the industry in alternative
fuel propulsion." (Redlac.org, para 2).
Business Operations: “GM designs, build and sell cars, trucks and automobile parts worldwide.“ There are
four major areas where GM sells there product (United States Securities and Exchange Commission, 2014,
p. 2). The four areas are (1) North America (2) Europe (3) South America and (4) other international
markets. GM also operates GM Financial that provides financing services (United States Securities and
Exchange Commission, p. 2).
4. About General Motors
GM currently leads all other competitors in percentage of market share in the U.S. A few key competitors
include Ford, Toyota, Chrysler, and Honda (Edmunds.com, 2014, p. 1).
A total of 18 risk factors were cited in GM‘s 2013 10K filing.
A few risk factors include increased costs, disruption of supply or shortage of raw materials, imbalances in
foreign currency. and potential loss of sales from a downturn in the economy (United States Securities and
Exchange Commission, p. 18).
GM strategies for success includes investing in creating new and improved vehicles, investing in new
technologies and creating joint ventures (United States Securities and Exchange Commission , p. 17).
Figure 1
5. GM᾽s Cost of Debt and Cost of Preferred Shares
Cost of debt is “the effective rate that a company pays on its current debt”
(Investopedia, 2015, para 1).
In 2013 GM‘s cost of debt is 5.01% .
Cost of preferred shares is expressed as “the preferred dividend divided by the
price of preferred stock” (Investopedia. 2015, para 3).
In 2013 GM‘s cost of preferred shares is 9.0 % (Yahoo Finance, 2015).
Figure 2
6. GM᾽s Cost of Debt and Cost of Preferred Shares Calculations
The formula that is used for Cost of Debt is the Interest rate*(1-Corporte Tax Rate)
(Investopedia, 2015, para 3).
In 2013 GM‘s interest rate was 7% and GM‘s corporate tax rate at 28.5% (United
States Securities and Exchange Commission, 2014, p. 35).
The cost of preferred shares formula is dividend yield/ price of preferred Shares
(Obaidullah, 2013, para 3).
GM‘s preferred share price on 2/20/2015 was $37.465 (Yahoo Finance, 2015). The
current yield is 3.2%.
Cost of Debt
7(1-28.5) =
Cost of Preferred Shares
3.2/37.465 =
5.01% 9.0 %
7. GM᾽s Cost of Equity (CAPM) and Weighted
Average Cost of Capital (WACC)
According to Investopedia (2015) “s firm's cost of equity represents the
compensation that the market demands in exchange for owning the asset and
bearing the risk of ownership” (para 2).
GM‘s cost of equity in 2013 was 10.79% .
The WACC is defined as “a calculation of a firm's cost of capital in which each
category of capital is proportionately weighted” (Investopedia, 2015, para 1).
In 2013 GM‘s WACC was 8.33%.
8. GM᾽s Cost of Equity (CAPM) and Weighted Average
Cost of Capital (WACC) Calculations
The formula that is used for Cost of Equity is the
Risk Free Rate + (Beta*(Market Rate- Risk Free Rate) (Obaidullah, para 6).
According to the U.S. Department of Treasury (2015) the risk free interest in 2013
was 0.04% (p. 1). This is based on the 20 year U.S. Treasury rate.
In 2013 GM‘s beta was 0.97 (Yahoo Finance, 2015).
The market rate is 11%. This figure represents the average return on the stock
market since 1928 (Pollock, 2012, para 18).
Cost of Equity
.04+ (0.97* (.11-.04) = 10.79%
9. GM᾽s Cost of Equity (CAPM) and Weighted Average
Cost of Capital (WACC) Calculations
The formula that is used for WACC is E/V* Re (D/V)*Rd* (1-Tc) (Source).
Data was taken from GM‘s 2013 year ending income and balance statements.
WACC
0.6592* 0.1079 + (0.3407)*5.01* (1-71.50) = 8.33%
Information taken from the Income Statement period ending 2013
Automotive Interest Expense 334
Income Before Tax 7458
Income Tax Expense 2127
Information taken from the Balance Sheet
Short-term Debt
Automotive 564 161 Shares Outsanding
GMFinancial 13594 37.465 Price
Long-term debt 60.31865 Market Cap
Automotive 6573
GMFinancial 15452
Shareholders Equity 42607000
Long Term Debts 22025000
Value 64632000
Equity 0.659225
Debt 0.340775
WACC
E/V * Re+(D/V)*Rd*(1-Tc)
E/V 0.6592245
D/V 0.3407755
Re 0.1079
Rd 5.01%
Tc 71.50%
WACC 8.33%
10. GM᾽s Capital Structure
According to Berk and DeMarzo (2014), “the relative proportions of debt,
equity, and other securities that a firm has outstanding constitute its capital
structure” (p.479).
“The owner of a firm should choose the capital structure that maximizes the
total value of the securities issued” (Berk & DeMarzo, p.500).
11. GM᾽s Capital Budget Analysis
GM is deciding whether to invest $1,000,000 into a new building.
In order to determine this we will use the WACC discounted rate method and show
a comparison between GM’s profit margin and IRR.
The WACC method is considered is “used to see if certain intended investments or
strategies or projects or purchases are worthwhile to undertake” (Weighted
Average, 2014).
According to Berk & DeMarzo (2014) the following three steps associated with the
WACC method (p. 630):
1. Determine free cash flow (FCF) of investment.
2. Compute WACC
3. Compute value of investment by
discounting the FCF using WACC
12. GM᾽s Capital Budget Analysis
Free cash flow was determined by operating cash flow minus
capital expenditures.
GM’s FCF was calculated at $3,100,000.
General Motor's FCF
Operating Cash Flow 10,100,000
Capital Expenditures 7,000,000
FCF (OCF - CE) 3,100,000
GM' project must create a higher return than the previously calculated 8.33%
WACC discount rate in order for it to be accepted.
The following equation is used in determining the WACC discount rate (Berk
& DeMarzo, p. 628):
𝑟𝑤𝑎𝑐𝑐 =
𝐸
𝐸+𝐷
𝑅𝐷+
𝐷
𝐸+𝐷
13. GM᾽s Capital Budget Analysis
The initial investment was $1 million and the actual value of the investment is
$50,631,680. There is a gain of nearly $50 million.
The equation to compute the value of an investment using WACC is as follows
(Cherewyk, 2015, p. 1):
Determine growth rate (g)
𝑮𝒓𝒐𝒘𝒕𝒉 𝒓𝒂𝒕𝒆 =
(𝒑𝒓𝒆𝒔𝒆𝒏𝒕 𝒓𝒆𝒗𝒆𝒏𝒖𝒆 − 𝒑𝒂𝒔𝒕 𝒓𝒆𝒗𝒆𝒏𝒖𝒆)
𝒑𝒓𝒆𝒔𝒆𝒏𝒕 𝒓𝒆𝒗𝒆𝒏𝒖𝒆
𝐺𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒 =
($155,427,000 − $152,256,000)
$155,427,000
𝐺𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒 = 2.04%
Value =
𝐹𝐶𝐹𝐹1
𝑊𝐴𝐶𝐶−𝑔
𝑉𝑎𝑙𝑢𝑒 =
3,100,000(1.0204)
.0833−.0204
Value = $50,631,680
Investment value = $50,631,680 - $1,000,000
Investment value = $49,631,680
14. GM᾽s Capital Budget Analysis
To further evaluate the project the gross profit margin and IRR are calculated.
The gross profit margin is 3.3%.
Gross profit margin =
(𝑆𝑎𝑙𝑒𝑠 −𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 )
𝑆𝑎𝑙𝑒𝑠
(155,427,000 − 150,296,000)
150,296,000
When comparing the WACC of 8.33% to the gross profit margin it does not
appear to have enough revenue coming in to make the expected return for
this investment.
If Team NYSE were to only look at this data the project would be declined.
15. GM᾽s Capital Budget Analysis
The IRR will provide the average return earned for the project that Team
NYSE is deciding to invest into (Berk and DeMarzo, 2014, p 210).
The IRR rule states that if the IRR is higher than the cost of capital take it,
otherwise turn it down (Berk and DeMarzo, 2014, p 210).
IRR is calculated by finding r.
The IRR is calculated at 11.98%.
𝑁𝑃𝑉 = −𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 +
𝐶𝑡
(1+𝑟)𝑡+ 0
1+r =
3100000
100000
1/10
IRR= 11.98%
16. GM᾽s Capital Budget Analysis
The internal rate of return, or discounted cash flow rate of return, offers analysts a
way to quantify the rate of return provided by each investment.
When comparing the IRR and WACC discounted rate it is clear the IRR is larger.
This means that GM should accept this project.
By calculating the WACC, value of the investment, as well as the IRR it is clear that
investing $1,000,000 is an acceptable project.
17. Conclusion
GM is considered the vehicle market leader in the U.S. as they currently outsell
Ford, Toyota, and other car manufactures.
An analysis that is based on finance calculations has supported the question of
GM borrowing one million dollars for a new building.
Key calculations that were explored and answered include cost of debt, cost of
preferred stock, cost of common equity, capital structure, WACC, gross profit
margin, and the IRR.
The determining factor that states why GM should accept the one million dollar
project is the IRR rate. The IRR exceeded the WACC, and this suggests that GM
should follow through with accepting the project.
18. References
Berk, J. & DeMarzo, P. (2014). Corporate finance (3rd ed.). Boston, MA: Pearson Education, Inc.
Cherewyk, P. (2015). Valuing firms using present value of free cash flows. Investopedia. Retrieved from
http://www.investopedia.com/articles/fundamental-analysis/11/present-value-free-cash-flow.asp
Cromwell, J. (n.d.). Description of capital budgeting. Retrieved from
http://smallbusiness.chron.com/description-capital-budgeting-15496.html
Edmunds.com (2015, February 4). Market share by manufacturer. Retrieved from
http://www.edmunds.com/industry-center/data/market-share-by-manufacturer.html
General Motors (2015). Company: About GM. Retrieved from http://www.gm.com/company/
aboutGM.html
Investopedia (2015). Cost of debt. Retrieved from http://www.investopedia.com/terms/c/costofdebt.asp
Obaidullah, J. (2013). Cost of preferred stock. Retrieved from http://termsexplained.com/128767/cost-
of-preferred-stock
19. References
Pollock, M.A. (2012). Why dividend stocks aren’t the new bonds: You can get generous yields…but also
considerable risk. The Wall Street Journal. Retrieved from http://www.wsj.com/articles/
SB10001424052970204542404577158761922787578
Scripophily.com (2015). Product description. Retrieved from http://scripophily.net/gemocode197.html
United States Securities and Exchange Commission (2014, February 6). General Motors Company 2013
Form 10-K. Retrieved from http://www.sec.gov/Archives/edgar/data/1467858/000146785814
000043/gm201310k.htm
U.S. Department of the Treasury. (2013). Daily Treasury Bill Rates. Retrieved from
http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?
data=yieldYear&year=2013
Yahoo Finance. (2015). Company profiles: General Motors Company. Retrieved from
http://finance.yahoo.com/q?s=gm&fr=uh3_finance_web_gs_ctrl1&uhb=uhb2
20. Appendix A
2013 GM Balance Statement
Period Ending Dec 31, 2013 Dec 31, 2012
Assets
Current Assets
Cash And Cash Equivalents 21,268,000 19,108,000
Short Term Investments 8,972,000 8,988,000
Net Receivables 33,162,000 23,868,000
Inventory 14,039,000 14,714,000
Other Current Assets 4,060,000 3,318,000
Total Current Assets 81,501,000 69,996,000
Long Term Investments 22,448,000 13,837,000
Property Plant and Equipment 29,250,000 25,845,000
Goodwill 1,560,000 1,973,000
Intangible Assets 5,668,000 6,809,000
Accumulated Amortization - -
Other Assets 3,181,000 3,040,000
Deferred Long Term Asset Charges 22,736,000 27,922,000
Total Assets 166,344,000 149,422,000
21. Appendix B
2013 GM Balance Statement
Liabilities
Current Liabilities
Accounts Payable 48,254,000 48,474,000
Short/Current Long Term Debt 14,158,000 1,748,000
Other Current Liabilities - - 3,770,000
Total Current Liabilities 62,412,000 53,992,000
Long Term Debt 22,025,000 3,424,000
Other Liabilities 38,733,000 55,006,000
Deferred Long Term Liability Charges - -
Minority Interest 567,000 756,000
Negative Goodwill - -
Total Liabilities 123,737,000 113,178,000
Stockholders' Equity
Misc Stocks Options Warrants - - -
Redeemable Preferred Stock - - -
Preferred Stock - 3,109,000 10,391,000
Common Stock 15,000 14,000
Retained Earnings 13,816,000 10,057,000
Treasury Stock - -
Capital Surplus 28,780,000 23,834,000
Other Stockholder Equity (3,113,000) (8,052,000)
Total Stockholder Equity 42,607,000 36,244,000
Net Tangible Assets 35,379,000 27,462,000
23. Appendix D
2013 GM Share Price
Symbol GM
Exchange NYSE
Price 37.465
Change
-0.045 (-
0.12%)
Volume 2.97M
Open 37.49
High 37.51
Low 37.16
Prev. Close 37.51
52 Wk High 38.18
52 Wk Low 28.82
Shares Out 1.61B
Market Cap 60.33B
Div/Shr 0.3
Ex-Div 3/9/2015
Pay Date 3/24/2015
Div Yield 3.21
PE Ratio 22.57
EPS 1.66
Editor's Notes
“When the firm finances its own project using debt, it will benefit from the interest tax deduction. One way of including this benefit when calculating the NPV is by using the firm’s effective after-tax cost of capital, which we call the weighted-average cost of capital” (Berk & DeMarzo, 2014, p.421). According to Berk & Demarzo (2014) “We generally determine the risk-free saving rate using the yields on U.S. Treasury securities” (p. 404).
“In many instances, the choice of leverage is of critical importance to a firm’s value and future success” (Berk & DeMarzo, 2014, p.508)
The rule of thumb when capital budgeting, or when evaluating a project, is to accept investments that have an IRR greater than the opportunity cost of capital. Under most conditions, the opportunity cost of capital is equal to the weighted average cost of capital (WACC).