In the first paragraph describe how the project will bring risk to the company or decrease the risk of the company.

This week your team will need the weighted average cost of capital to use for each project. For projects in the existing line of business the appropriate cost of capital is the firm’s cost of capital (or in Chipotle’s case an 8% cost of capital is warranted). For project outside the normal course of business, the cost of capital must be adjusted up or down from the corporate rate compensate for the increased risk or the decrease risk brought to the corporation by the acceptance of this project.

The write up should read some as follows:

For the ____________________ project we believe this project will have more risk, have less risk, or will equal risk (pick one) with Chipotles’ existing business. For the following reasons ………………………………………………………………

If the project is outside the normal operations of the firm, such as entering a new line of business, franchising, urban farming, international expansion, adding bars, then look up the betas for firms in that business and their debt to total assets percentages. For menu expansion projects, your job is done because these projects would have equivalent risk to existing operations of Chipotle. So, you do not need to go any further.

Some groups may go outside Chipotle’s normal business and enter industries with different risk profiles. For these groups you will need to do the following:

• For a new line of business, franchising, drive thrus, I would suggest using YUM, Wendy’s, and McDonalds look up their betas on Yahoo Finance and average these betas.
• For farming and or urban farming I would suggest using the betas of Fresh Del Monte (FDP), Archer Daniels Midland (ADM), and Bunge (BG)
• For international expansion I would suggest using YUM Brands of China (YUMC) and Arco Dorados Holdings (ARCO) as a proxy companies in international restaurants. You will need to use Yahoo finance to find their beta and then average these.
• For adding bars, I would average the betas for Dave and Busters’ (PLAY), BJ Restaurants (BJRI), and Chuy’s (CHUY).

Your group will need to get or calculate the average Betas for the firms, the average debt levels (in dollars) and average market capitalizations for these proxy companies (more about how to do this later in these instructions). After you have collected these data, you can use the following assumptions in calculating the project’s weighted average cost of capital:

• Debt will have an after-tax cost of 4%.

When using the capital asset pricing model to calculate the cost of equity capital use these assumptions:

• The risk-free rate of return is 3.5%
• The Beta is whatever you averaged from the proxy companies.
• The market risk premium is 5%

To get your weightings of debt and equity:

• Look up the debt levels for each company using balance sheets (be careful to have the correct number of zeros – many are in thousands).
• Take the stock price times the total share outstanding to get the company’s market capitalization or value of equity or read it from Yahoo Finance.
• Add the two and divide by the total to get the weightings.

Complete the calculation of this project or divisional cost of capital as illustrated in the lecture notes.

• Take the 4% cost of debt times the weighting for debt
• Take the cost of equity capital (as calculated by the capital asset pricing model) times the weighting for equity
• Add the two to get the weighted average cost of capital

Below your group will find a URL to a YouTube Video that illustrates the procedure to calculate a project cost of capital for a project outside the normal course of the firm’s business:

STEPS TO COMPLETE THIS WEEK’S ASSIGNMENT:

This week your team will need the weighted average cost of capital to use for each project. For projects in the existing line of business the appropriate cost of capital is the firms cost of capital (or in Chipotle’s case an 8% cost of capital is warranted). For project outside the normal course of business, the cost of capital must be adjusted up or down from the corporate rate compensate for the increased risk or the decrease risk brought to the corporation by the acceptance of this project. Specifically, please do the following:

1. Identify yourself and your team members at the top of the first page.
2. In the first paragraph describe how the project will bring risk to the company or decrease the risk of the company. If the project is within the existing risk profile of the company — you do not need to do the next step- but you will need an explanation of why you think the project meets the existing risk profile of the company.
3. If the project is outside the normal operations of the firm, such as entering a new line of business, franchising, farming, urban farming, international expansion, adding bars, drive thrus, food trucks, etc, then
   1. look up the betas for firms in that business and average the betas for these firms,
   2. recalculate the cost of equity for this project,
   3. find the average debt to asset level in this new industry,
   4. recalculate the weighted average cost of capital for the project (please show your work in how you calculated this project’s weighted average cost of capital .

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