General Motors Inc.Joseph FeldmanFINU-607-OL3

Brandman UniversityMarch 4, 2015

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.

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).

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

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

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 %

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%.

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%

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.

WACC0.6592* 0.1079 + (0.3407)*5.01* (1-71.50) =

8.33%

Information taken from the Income Statement period ending 2013Automotive Interest Expense 334Income Before Tax 7458Income Tax Expense 2127Information taken from the Balance Sheet

Short-term DebtAutomotive 564 161 Shares OutsandingGM Financial 13594 37.465 Price

Long-term debt 60.31865 Market CapAutomotive 6573GM Financial 15452

Shareholders Equity 42607000Long Term Debts 22025000Value 64632000Equity 0.659225Debt 0.340775

WACCE/V * Re+(D/V)*Rd*(1-Tc)E/V 0.6592245D/V 0.3407755Re 0.1079Rd 5.01%Tc 71.50%WACC 8.33%

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).

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 WACC3. Compute value of investment by discounting the FCF using WACC

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 = 𝐸𝐸+ 𝐷𝑅𝐷+ 𝐷𝐸+ 𝐷

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 = 𝐹𝐶𝐹𝐹1𝑊𝐴𝐶𝐶−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

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.

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 = ቀ3100000100000 ቁ1/10

IRR= 11.98%

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.

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.

ReferencesBerk, 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

ReferencesPollock, 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

Appendix A2013 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

Appendix B2013 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

Appendix C2013 Gross Profit Margins

Appendix D2013 GM Share Price

Symbol GMExchange NYSEPrice 37.465

Change -0.045 (-0.12%)

Volume 2.97MOpen 37.49High 37.51Low 37.16Prev. Close 37.5152 Wk High 38.1852 Wk Low 28.82Shares Out 1.61BMarket Cap 60.33BDiv/Shr 0.3Ex-Div 3/9/2015Pay Date 3/24/2015Div Yield 3.21PE Ratio 22.57EPS 1.66