debt, equity, or retained earnings. The mixture of debt and equity is the company’s capital structure. There are four factors that influence capital structure; business risk, tax position, financial flexibility, managers, growth rate, and market conditions. Management’s decisions concerning capital structure should be geared toward maximizing the intrinsic value of the company. This value is the present value of its expected future free cash flows (FCF) discounted at its weighted average cost of capital
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investments would you value using Marriott’s WACC? (Note: the WACC formula is on page 398 of the textbook. You might want to answer these questions on your way to WACC: a. What risk-free rate and risk premium did you use to calculate the cost of equity? The risk free rate used was a weighted average of the short-term treasury bills and long-term bond rates found in Exhibit 4. Using a weighted average based off the amount of revenue for each of the three divisions, long-term bond rate of 4.58%
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increase shareholder’s wealth or lead the company to insolvency. Under the net present value method, the weighted average cost of capital is used as the discount rate to calculate the present value of future cash inflows. Hence, for the case study, we will compute for the WACC, prepare projected cash flows then compute the NPV. Solution WACC The all-equity beta (β) of Dixon is 1.06. We assume that we could have a beta of 1.9 for the production of sodium chlorate, basing from the
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has just issued a dividend of $1.50 per share on its common stock. The company paid dividends of $1.10, $1.15, $1.25, and $1.37 per share in the last four years. The stock currently sells for $48. a. What is your best estimate of the company's cost of equity capital using the arithmetic average growth rate in dividends? b. What if you use the geometric average growth rate? Solution: (3 + 2 = 5 Marks) Part a. Period 1 2 3 4 5 dividend 1.1 1.15 1.25 1.37 1.5 Average growth (Arithmetic) growth 0.045
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few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice-president. Your first task is to estimate Harry Davis’ cost of capital. Jones has provided you with the following data, which she
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related to the project: a. Sunk cost- A cost that cannot be recovered because the funds are already spent. An example of a sunk cost for AirJet best Parts could be: AirJets Best made an investment of $500,000 to provide project research through an extensive survey. This would be a sunk cost because once the survey was completed the money could not be recovered. b. Opportunity Cost- This is the cost of giving up one thing for another. An example of opportunity cost for AirJet Best
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article “The cost of capital, corporate finance and the theory of investment”. Before Modigliani’s and Miller’s article, literature on the topic mainly focused on descriptions of methods and institutions. Theoretical analysis was very rare (Pagano 2008). Under the assumption of perfect capital markets, the Modigliani-Miller Proposition I states that “the average cost of capital to any firm is completely independent of its capital structure and is equal the capitalization rate of a pure equity stream of
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Cash Flow and Cost of Capital Learning Objec-ves 2 ¨ Cash flow to invested capital ¤ $4,000.00 $3,500.00 $3,000.00 $2,500.00 Free cash flow NOA NIBCL NOA ¨ Rate cost of capital ¤ NIBCL C IC OA Weighted average cost of capital Includes all costs of capital Fair value of invested capital $2,000.00 $1,500.00 $1,000.00 $500
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binding obligation that gives party the right to demand the performance of whatever promised * management (agency problem) – information asymmetry, act in self interest * debt Stewardship – compliance with delegated authority Agency Cost of equity Perquisite consumption – Manager give themselves more luxury than would seem reasonably from the principals point of view. E.g. corporate jets and huge officers with expensive art Risk aversion – managers and shareholders may prefer different
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1. COLEMAN SYSTEM BACKGROUND INFORMATION 4 2. COST OF CAPITAL FOR COLEMAN SYSTEMS 5 2.1 Calculate cost of debt (rd) 5 2.2 Calculate ratio debt/capital and equity/capital in market value terms 6 2.3 Calculate Beta (β) for Coleman Systems 8 2.4 Calculate Cost of Equity 10 2.5 Calculate the weighted average cost of capital for Coleman Systems 10 3. THE WACC AND PROJECT VALUES FOR DIFFERENT DEBT – EQUITY RATIOS AND THE OPTIMAL CAPITAL STRUCTURE FOR THE PROJECT
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