earnings as evaluated is questionable. Under the value-creating investment prong‚some projects were considered as future equity cash flows using the cost of equity as the discount rate instead of the hurdle rate based on the project or divisional WACC. The calculation of EVA (economic value added) was manipulated by a “capital charge” and the “capital charge” was
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EVATM (economic value added) from 2001 to 2003. Students also need to determine each company’s weighted-average cost of capital (WACC) to estimate EVA. The primary objective of this case is to introduce students to the concepts and calculation of WACC and EVA. Suggested Questions: 1. What is the weighted-average cost of capital (WACC) and why is it important to estimate it? Who determines the WACC? 2. Calculate the WACCs for Coca-Cola and PepsiCo. Assume a tax rate of 35%. Be prepared to
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Chapter 8 The Cost of Capital 236 CHAPTER 8—THE COST OF CAPITAL TRUE/FALSE 1. Capital refers to items on the right-hand side of a firm’s balance sheet. 2. The component costs of capital are market-determined variables in as much as they are based on investors’ required returns. 3. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt. 4. The cost of issuing preferred stock by a corporation must be adjusted to an after-tax
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40 | 9 | 14 | 12.00% | 50 | 10 | 15 | 12.50% | 60 | 12 | 16 | 13.60% | b. Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Compare this balance sheet with the firm’s current balance sheet. What course of action should the firm take? Assets $100‚ Debt $?‚ Equity $? Using the WACC at the minimum gives the optimal Capital Structure‚ which is 20% Debt. Assets | $100 | Debt | $20 | | | Equity | $80 | Total Assets | $100 | Total Debt & Equity |
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cost-of-capital‚ helps determine the accuracy of estimating costs‚ and solves the problem of how a company really estimates their cost of capital. When dealing with the estimation of capital costs‚ companies are left to their own discretion on how to estimate such a cost. Surveys conclude that about 93% of companies us a weighted-average cost-of-capital along with some sort of discounting in their capital budgeting. Smaller companies tend to use a capital-asset pricing model (CAPM) along with the WACC when estimating
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capital is what it will cost the firm‚ on the margin‚ today‚ to secure its financial resources for further growth. • Cost of capital must reflect current capital market conditions (current required returns) • Cost of capital must also reflect the optimal relative proportions of debt and equity the firm will use in the long run and which (the capital structure) consciously reflects a proportion that will maximize the value of the firm. Why is it important to calculate the Cost of Capital?
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DELUXE CORPORATION Contents Section 1: DELUXE Corporation 1.1. 1.2. 1.3. 1.4. Company Business Overview Macro-Evironment & Industry SWOT Analysis Porter’s Five Forces Section 2: Business & Strategy Risks / Financing Requirements Section 3: Main Objectives of the Financial Policy Section 4: Financial Flexibility – Cost of Capital Section 5: Is Deluxe’s Current Debt Level Appropriate ? Section 6: FRICTO Analysis Section 7: Conclusion - Recommendations 2 Section 1: DELUXE
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BBB ‚ which results in a decrease in WACC from 11.47% to 9.95%. By doing this‚ Deluxe ’s WACC is minimized‚ yet the bond rating is still at investment –grade rating; plus‚ the firm will have a financial flexibility of $872 million‚ and an increase in its equity value per share by $35.34. This memo explains in detail the calculation of the current WACC‚ the current intrinsic equity value‚ the unused debt capacity at different ratings‚ and the recommended WACC as well as the estimated increase in
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Cost of Capital Firms need to make capital investment i.e.‚ purchasing fixed assets such as factories‚ machineries‚ equipment‚ etc. After deciding what capital investments to make‚ they need to decide on the financing – sources of capital. The sources: Long-Term Debt‚ Common Stock‚ Preferred Stock and Retained Earnings. Then they need to find the cost of obtaining each source of financing today (not historical). Cost of Capital - The rate of return that a firm must earn on its investment
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E. Capital structure 5.1 Key factors that affect structure choice 5.1.1 Profitability and variation of profitability Profitability is one of the most tested company characteristics in empirical research regarding companie’s choice of capital structure. The trade-off theory predicts that higher profitability is associated with increased debt levels and the reason for this is twofold. First‚ companies achieving high profitability have less risk of financial distress and bankruptcy‚ so the cost
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