According to http://finance.yahoo.com, "Statistics", what are the given values of CAT's "Market Cap (for common stock equity)" E and "Total Debt (for long-term debt)" D, respectively? And thus what shall be CAT's "weight of equity capital, we" and "weight of debt capital, Wad", respectively? Hints: For example, pretending a firm’s reported “Market Cap” is $75 billion, “Total Debt” is $25 billion, then We = 75 bill / (75 bill + 25 bill) = 75 bill / 100 bill = 0.75 (or 75%), and Wad = 25 bill / (75 bill + 25 bill) = 25 bill / 100 bill = 0.25 (or 25%). Be careful, in financial management and Wall Street, "Market Cap" does not mean the sum of all capital (E + D), but instead only refers to the equity E alone. Also review Professor Leo's sample solutions for HWs of previous chapters: From Ch. 10 HW Part B, Application 1, we find that CAT longest-maturity bond's yield-to-maturity is xxx% per year. This data can be used to measure CAT's cost of longest-term debt, Rd; From Ch. 10 HW Part B, Application 2, we find that CAT stock's required return is yio% per year, based on the calculation of dividend growth model DGM, R = D0(1+g)/P0 + g. This data can be used as one alternative to measure CAT's cost of common stock equity, Re; From Ch. 13 HW Part B, we find that CAT stock's required or expected return is zizz% per year , based on the calculation of capital asset pricing model CAPM, R = Rf + BETA (Mr - Rf). This data can be used as another alternative to measure CAT's cost of common stock equity Re. Hints: Neither DGM nor CAPM is perfect (the former uses current data but ignores market risk, can't be applied on stocks that pay no dividends, so it is "current but not stable"; the latter considers market risk but relies on outdated historical average data, can be applied on stocks that pay or do not pay dividends, so it is "stable but not current"). Thus, the best method to estimate Re shall be "the average of both DGM and CAPM calculation outcomes." Calculate the average of two alternatives to get the best estimate of CAT's re. An applicable corporate tax rate is given as Tic = 35% (Federal income tax only) for CAT, as for most of large US firms. Marginal tax rate shall be used in this case, because corporate investment decisions are incremental (i.e., additional on existing business scale, not everything is brand-new from scratch). Based on all these collected data of Wad, We, Rd, Re and Tic, compute CAT's WACC. Let's recall the prior exercises in Ch. 10, and see what the WACC shall be used for. In “HW for Chapter 10, Part B” Caterpillar exercises, we find that to finance capital investment projects, using debt capital alone will cost relatively less [particularly after multiplying yield-to-maturity Rd with (1 - Tax rate), with tax deduction benefit on corporate debt interest expenses] but will increase the bankruptcy risk; while using equity capital alone will lower the bankruptcy risk but the cost of equity could be higher compared with the after-tax cost of debt capital. So, the best way to finance an investment project while keeping the firm's growth sustainable is to "use some debt, and use some equity, therefore keeping the existing debt-equity ratio constant and not off-balance." As a result, the best required return (i.e., discount rate, or cost of capital) for an investment project is the firm's WACC, which is the weighted average of debt and equity capital! Assume CAT wants to consider investing on the computer order-entry system described in Chapter 10, Ex. 14. The discount rate for NPV and IRR analysis shall then be CAT's WACC. Based on the IRR analysis, shall CAT purchase the order entry system or not? Based on the NPV analysis, shall CAT purchase the system or not? What would be the resulting NPV amount being added by this system project to CAT investors? The key points of learning: Yield to maturity, CAPM model, and dividend growth model are for the purpose of calculating WACC; whereas WACC is for the purpose of being used as the discount rate (i.e., required return, cost of capital financing) for NPV and IRR analysis! So those chapters are closely linked to each other. I will not directly tell you so again in the exam questions, but you are supposed to keep such logics in your own mind --- in particular, if you get a firm's WACC, you then shall know what discount rate shall be used for this firm's NPV and IRR decisions.