...the corporate and divisional cost of capital for the next fiscal year and along with the estimations, several assumptions and arguments will be discussed to provide better overview and understanding of the whole process to the managers. II. INTRODUCTION TO WEIGHT AVERAGE COST OF CAPITAL (WACC): WACC is the weight average of the expected after-tax rates of return for all firm’s various sources of capital (Sheridan, 2011). In Midland, WACC is considered as the market-based weight average of the after-tax cost of debt and cost of equity: Estimation of WACC was used in many researches and analyses within Midland, including asset appraisals for capital budgeting and financial accounting, stock repurchase decisions, performance assessments, and project valuations. The above estimation of WACC requires the calculations of its three components: the cost of equity, the after-tax cost of debt and the firm’s target capital structure. Since changes in these above anticipated uses may affect the corporate target capital structure, various uses of WACC in corporate operations may relatively generate different results of WACC. III. ESTIMATION OF MIDLAND CORPORATE WACC: 1. Cost of Equity: It reflects the risk of cash flows to common equity holders who are the residual claimants of the firm’s earning. As the expected rate of return on a company’s stock is unobservable, thus the estimation has to rely on asset...
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...was targeted to service routes in a critical high growth market segment. The chief objective of the analysis is to evaluate the 777 against a financial standard. The case gives internal rates of return (IRRs) for the 777 project base case and alternative forecasts. The principal analytical problem of the case is an estimation of a weighted average cost of capital (WACC) for Boeing’s commercial aircraft division in order to evaluate these IRRs. The analysis should also identify ‘key value drivers’ and distinguish, on a qualitative basis, the key gambles Boeing is making. Capital budgeting projects should promote the primary goal of the firm; therefore, the primary goal directs decision making. Frank Shrontz, Boeing’s CEO, says his mission is raising Boeing’s return on equity from the recent average of about 12 percent. Is the primary goal of Boeing improving return on equity? 1. Frank Shrontz says he wants to improve Boeing’s return on equity. How might the 777 project serve that mission? Is improving return on equity the same as maximizing shareholders’ wealth? 2. Boeing has historically shown an aversion to debt financing with the book value of debt making up only 4 percent of total capital (page 201). Is this low leverage consistent with the goal of increasing return on equity? 3. Can we assume that Boeing’s primary goal is maximizing shareholders’ wealth? Your decision on the Boeing 777 will be in the context of the...
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...selected, this report is to provide the reasons why Network I is better. Before finalize the decision to select between Network I and Network II, there are three steps: 1. The forecasted net cash flow derived for both Network 2. Techniques use to evaluate Networks 3. Final decision to accept Network I 1. Forecasting cash flow for both Networks As attached in Appendix I, to get free cash flow for these two projects, there are 3 stages: 2.1 Calculation of Cost of capital “Capital asset pricing model (CAPM) gives a condition under which we can generalize about the structure of expected return of a share in market” (Benninga 2008, p. 319). We use this discount rate to calculate the net present value of the projects. The formula is E (ri) = rf + E(rm – rf) i = 18.66% Where E (ri): required return on the equity of stock i E(rm – rf): expected return on the market over and above the risk-free rate rf: risk-free rate 2.2 Profit calculation Before calculating of cash flow forecasts, incremental profit before tax should be derived first. Incremental profit before tax is defined as revenue less operating expense and depreciation, but plus opportunity cost from not paying the fee to Commonwealth Bank if the Capital Bank switches to either Network I or II. 2.3 Cash flow calculation The remaining cash flows include initial investment on ATM and installation cost, the changes in working capital, the final recovery of salvage value, taxation...
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...period, the price fluctuated from $47 at FYE 2008, down to $34 at FYE 2009 and back up to $47 at FYE 2010. Accordingly, Heinz was considering whether or not to adjust their cost of capital to reflect these changes as they occurred. This gives rise to two questions: To what degree should these stock price changes affect cost of capital? How often should the cost of capital be re-estimated? To address these questions, we first estimated Heinz’s WACC at the time under the given market conditions In order to prepare our estimation for the WACC, we first made educated assumptions for the variable inputs of the WACC equation. Our assumptions and source behind each are as follows: Table 1: The assumptions and corresponding source, used in the Heinz WACC estimation Assumption Source Risk Free Rate: 4.5 % Based on the 30-year Treasury Yield as of April 2010 (Exhibit 3 of case) Market Risk Premium: 7.5% Based on long-term estimates (case, page 5) Beta: 0.62 Based on 5 year average (case, page 5) Cost of Equity: 9.18% Calculated using CAPM and above data Cost of Debt: 3.16% Calculated using bond data (Exhibit 3) Value of Equity: $14,890,130,300 Calculated based on share price of $46.87, multiplied by outstanding shares of 317.69 million (Exhibit 2) Value of Debt: 4,559,152 In lieu of a market value, the book value of...
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...Institute of Management, Lucknow Contents Data 3 Sample 3 Methodology 4 Alpha and Beta Estimation 4 Event Study 4 Hypothesis & Objective 5 Testing & Results 5 Alpha and Beta calculation 5 Event Study 6 Stock Split 7 Reverse Stock Split 8 Conclusion 8 Data 1. This study includes samples of 19 companies that made a stock split announcements and 9 companies that made a reverse stock split announcements. All the companies were listed on BSE. 2. Data for daily stock prices and closing BSE 500 index for this study was collected from http://finance.yahoo.com/. Sample The below tables show the sample companies selected for the event study. Companies selected for stock Split announcements Companies selected for reverse stock split announcements Methodology The event period was decided as -60 to 60 with the announcement date falling on day 0. Alpha and Beta Estimation 1. Alpha and beta was estimated for each company by regressing daily stock returns with index return. 2. The estimation was a done for a 250 day period prior to -60. This period was selected to minimize any noise that could arise due to the announcement of stock split/reverse stock split. 3. Actual return was calculated for all the companies as well as for the BSE 500 during the 250 day period. Actual return was obtained from the following formula: Daily Return = (current day adj close price – previous day adj close price) / prev. Day adj close price ...
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...Dividing $5,023.28M by $14,591.43M (sum of market value of debt plus the market value of equity) and multiplying by 100 gives the percent debt of 34.43%. Please see Exhibit 1 for calculations. The pretax cost of debt capital will be the yield to maturity of a proxy bond. The bond that matures on 2/15/2013 will be used as a proxy for the entire cost of debt capital because of its relative size in relation to the entire company’s debt capital. Additionally, the maturity date most closely matches when the largest amount of cash inflows will be needed by Boeing. The yield to maturity of this bond is 4.657%. Though the marginal effective tax rate is listed as 35% in cash flow estimations from the case, this is seems like too aggressive of a number. Instead, the tax rate I will use in estimations will be 27.1%. The...
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...has a slight bias towards large companies. From 2000 to 2012, the daily data on closing prices of the stocks and the KSE100 index were obtained from the Karachi Stock Exchange Data Portal, which is the primary source of all stock data in the country. Monthly stock returns for each stock are calculated using this data. Monthly market returns were calculated from the broadly-based, capitalization weighted KSE 100 index as the KSE 100 Index was taken as the market portfolio. The three months treasury-bill rate was used as risk-free rate. The data on six-month treasury-bill rates was obtained from the Market Treasury Bills Auction Results from the State Bank of Pakistan data Portal. Methodology- Betas are estimated using the single period, discrete time Market Model (MM) developed by Markowitz (1959) Shape (1963).The MM is expressed as, Rit = αit + βiRmt + εit, -----------------(1) Where Rit is the expected return on an asset “,i”, Rmt is expected return on market portfolio, proxied by the stock market index and βi is the “beta” or the measure of risk or market sensitivity parameter. Rit is measured as the continuously compounded return on the i'th security during time t, while Rmt is the corresponding return on the market. In equation 1, α and β are unknown firm specific parameters assumed to be constant over time,...
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...The first problem we faced in calculating the expected returns was whether or not to used a historical average or calculate beta and apply the CAPM. We decided to find beta and calculate the CAPM. The reasoning is that our investor is interested in forecasting future returns. Even though beta is theoretical and largely inaccurate, it is the best tool available to the analyst. To calculate beta we considered three methods. The first was to look up historical betas for each of the assets. We used Yahoo Finance. The second method was to use the formula; CovRm, RiVarRi and apply it to each of the funds. Lastly, we regressed the monthly returns of each of the assets with the monthly market risk premium to estimate beta (see exhibit 1). For our purposes we valued the covariance formula and the regression analysis more than historical data since we are more interested in forecasting. The output for these methods returned almost identical results for every fund so we used the average of the two as our estimated beta. There were three exceptions – the last three assets (TIDRX, TIKRX, and TIQRX). We felt that there might not have been a large enough sample set to get an accurate result from the same type of analysis, so we defaulted to the historical figures calculated by Yahoo Finance for these three assets. Next, we considered alpha. We strongly feel that markets are efficient and any estimation of alpha for use to identify under or overvalued assets – in essence...
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...ft Beta Estimation Practice And Its Reliability Biasness Towards Aggressive Stocks: An Empirical Evidence From NSE * Dr. Neeraj Sanghi ** Dr. Gaurav Bansal INTRODUCTION While investing in a capital market, investors always have concern about the market movements or changes in the value of capital market index. This tendency of investors' behavior is related to a psychological factor that reveals that market movements and prices of stocks are closely related to each other. Upward / downward movement in market index gives trigger to the expectation of investors that the value of their holding would move accordingly. This is, more formally, known as systematic risk arising on account of economic wide uncertainties and explains the tendency of stock's price movement together with changes in market index. Systematic risk, also known as market risk, cannot be reduced through diversification of stocks' portfolio. Investors arc exposed to market risk even when they hold well diversified portfolio of securities. In finance literature, beta coefficient is a measurement statistic of systematic risk; it refers to the slope in a linear relationship fitted to data on the rate of return on a stoek and Ihc rate of return of the market (or market index). This usage stems from Sharpe's 1963 paper in Management Science. Beta is the stock's sensitivity to the market index: it is the degree (in percentage) by which the stock's relum lends to increase or decrease for every 1% increase or decrease...
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...paper, I will continue to work on A. Schulman, Inc (SHLM) along with its two biggest competitors PolyOne Corporation (POL) and Dow Chemical (DOW). Rate Of Return To calculate the rate of return for each of the firms for last three years, I used the adjusted yearly close price, which includes dividends and splits. ( please refer to Appendix I ). Clearly, the three companies were hurt by the financial crises. Especially in 2008, they all had losses. However, Schulman had lost the least compared to PolyOne, which was the biggest loser. After 2008 all three companies adjusted their position and gained profits. You can notice that PolyOne which recorded the highest losses in 2008, gained the highest returns in 2009 compared to the Dow and Schulman that had the least profits. In 2010, the three companies continued to earn profit but with a weaker momentum. Expected rate of return In order to estimate the rate of return for the following year, I have estimated the probability of having strong, normal, and weak demand. Since I believe that the market characteristics have somehow changed after the financial crises, I’ve based my estimates for the rate of return on the last 10 years with some adjustments to make it more related to after the recession period. (Refer to Appendix II) In my estimation of the expected rate of return, the three companies will slightly continue to grow profit. Of course that depends on how long it is going to take for the oil prices to drop, due to the action...
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...Financial Accounting Theory Test 1: 1) Please briefly describe the essences of the following cases of accounting scandal or earnings management. (20 points) A) ENRON (8 points) * Enron created many special purpose entities (SPEs) controlled by senior Enron officers that they used in conducting off balance sheet financing * SPE’s borrowed money from banks using Enron’s stock as collateral However all of the liability was reported on the SPE’s books, not on Enron’s, even though the borrowed cash went to Enron * Thus investors had no idea of Enron’s debt because they did not consolidate the SPE’s like they were suppose to under GAAP * Enron also charged fees for management and other services supplied to their SPE’s and included appreciation of its own stock which exaggerated net income * They had to consolidate their financials resulting in a reduction of shareholder’s equity, restatement of previous 4 years earnings, loss of investor confidence, share price fell from $90 to 66 cents then 1 cent * The SEC revoked the auditing license of accounting firm they used, Arthur Anderson B) MCI WORLDCOM (8 points) * From 1999-2002 they overstated their earnings by $11 billion * $4 billion of this amount was from capitalization of network maintenance and other costs that should have been expensed * and $3.3 billion came from reductions in the allowance for doubtful accounts * WorldCom’s merger with MCI was a disaster and went bankrupt...
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...Estimate Risk-Free Rate ii. Estimate Risk Premium iii. Estimate Beta * Unlevered beta: the beta a company would have if it were all equity financed * CAPM: beta estimated relative to market portfolio * APM / Multi-factor: betas relative to each factor have to be measured. There are 3 estimation approaches: * Historical market betas (most used): regressing stock returns against market returns. Analysts often obtain these from estimation services. * Fundamental betas (bottom-up): betas determined by (i) type of businesses the firm in is, (ii) degree of operating leverage (fixed costs relative to total costs), (iii) firm’s financial leverage. * Accounting betas: look at changes in the firms’ earnings vs. changes in earnings for the market. * For private firms, may have to estimate betas using comparable publicly traded firms. * Estimating the cost of equity * Cost of equity is the return shareholders expect to make. If firms don’t deliver this, the SHs become restive and rebellious. * CAPM: Expected return = riskfree rate + beta * expected risk premium * Cost of equity is usually much higher than the cost of debt Cost of Capital * Weighted average of the costs of the different components of financing: debt, equity, hybrid securities. 3 evaluation approaches: * Unlevered cost of equity approach: cost of equity using an unlevered beta. *...
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...For other uses, see Beta. In finance, the beta (β) of a stock or portfolio is a number describing the relation of its returns with that of the financial market as a whole.[1] An asset with a beta of 0 means that its price is not at all correlated with the market. A positive beta means that the asset generally follows the market. A negative beta shows that the asset inversely follows the market; the asset generally decreases in value if the market goes up and vice versa.[2] The beta coefficient is a key parameter in the capital asset pricing model (CAPM). It measures the part of the asset's statistical variance that cannot be mitigated by the diversification provided by the portfolio of many risky assets, because it is correlated with the return of the other assets that are in the portfolio. Beta can be estimated for individual companies using regression analysis against a stock market index. Contents [hide] * 1 Definition o 1.1 Securities market line * 2 Beta volatility and correlation * 3 Choice of benchmark * 4 Investing * 5 Academic theory * 6 Multiple beta model * 7 Estimation of beta * 8 Extreme and interesting cases * 9 Criticism * 10 See also * 11 Notes * 12 External links [edit] Definition The formula for the beta of an asset within a portfolio is \beta_a = \frac {\mathrm{Cov}(r_a,r_p)}{\mathrm{Var}(r_p)} , where ra measures the rate of return of the asset, rp measures the...
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...CASE STUDY HOMEWORK CORPORATE FINANCE 1 The Situation: In 2010 a new company was created in order to enter into the food industry. They spent many months in studying the market, engineering the products and the commercial strategy, find out the production plants. At the end of 2010 the business plan is ready and the company has already participated to an exhibition where many potential customers said to be very interested to the project. The problem: A private equity institution gets in touch with the company in order to buy 30% of the company buying new shares. The company wonders about the value of such shares, that is why the company asks a consultant to provide an estimation. The business idea: To manufacture in Italy, thanks to the well-known reliable partners, in order to maintain high quality. This way the company will be the leader in the market. To create franchising shops, in order to develop the brand and the customers' loyalty. To let franchisee pay weekly only the final goods he has already sold. This way: The company knows the daily amount of sales and also the product mix. Moreover it becomes easier to modify the production and to minimize the stock. Cash-inflows get closer, while the working capital investment becomes lower with a lower customer credit risk. Financial forecast: The business plan has been developed looking at an exhaustive market analysis. Forecast data are reliable; they refer to the first five years. The target is to open 80 franchising...
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...BRIEF INFORMATION ABOUT MIDLAND ENERGY RESOURCES Midland Energy Resources was a global energy company with operations in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. It had been incorporated more than 120 years and had more than 80,000 employees in 2007. Its consolidated operating revenue, operating income and total assets were $248.5 billion, $42.2 billion and $262.4 billion respectively in 2006. Midland’s E&P division operated in all parts of exploration, development, and production of which production was the dominant operation according to operating results reported in 2006. Also E&P is the most profitable division of Midland. On the other hand, R&M is the largest division in terms of revenue. Midland had ownership interests in 40 refineries all over the world. In the field of this division, there was stiff competition. Midland’s technology is advanced and with the vertical integration it makes Midland market leader in this business. The smallest division of Midland is petrochemicals. Midland’s financial and investment strategies for 2007 was built on four pillars, which are to fund overseas growth, to invest in value-creating project across all divisions, to optimize its capital structure, and to repurchase undervalued shares. Midland used estimates of cost of capitals in many analyses such as asset appraisals for both capital budgeting and financial accounting, performance assessments, M&A proposals, and stock repurchase...
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