Review Guide 1) Operating Leverage vs. financial leverage: Laurence A high degree of Operating Leverage means that a relatively low change in sales will result in large change in EBIT. If all things are held constant, the higher the firm’s fixed cost the greater its Operating Leverage. In Jacque’s words, this has to do with volatility of the top line. Those firms are usually highly automated, capital intensive, hire highly skilled individuals (read pay them huge salaries), and engage into costly
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Nike Cost of Capital I. Single of Multiple Costs of Capital Since Nike has multiple business segments it is appropriate to question whether to use single or multiple costs of capital for the analysis. Kimi’s assistant Joanna went ahead and chose to use one cost of capital for Nike. We agree with her decision because Nike’s different segments are all generally sports related and are susceptible to the same market risks. For example, Nike’s footwear and apparel lines, which make up a combined 92%
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DCF analysis The value of a company today, based on how much money it’s going to make in the future Dividend discount model (DDM) Free cash flow to equity – determine the fair value of companies One must consider * Future sales growth, profit margins * Discount rate – depends on a risk-free interest rate 1. Forecast period & forecasting revenue growth * How far we should project cash flows * Excessive return period * One can guess based on the company’s competitive
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discussing about the calculation of cost of capital in order to make investments and they are uncertain about the costs which should be consider while calculating the cost of capital. The investment is always made if expected rate of return is greater than its cost of capital. Cost of Capital Before calculating the cost of capital I'll calculate cost of equity and cost of dept and capital structure for ENCANA: 1 Cost of Debt: ENCANA cost of debt included cost on short term debt , long term debt
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Chapter 13 What is operating leverage, and how does it affect a firm’s business risk? Operating leverage is the use of fixed costs rather than variable costs. If most costs are fixed, hence do not decline when demand falls, then the firm has high operating leverage. Effect of operating leverage More operating leverage leads to more business risk, for then a small sales decline causes a big profit decline Typical situation: Can use operating leverage to get higher EBIT or operating
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increases, the expected rate of return on equity rises by just enough to compensate for its higher risk. The stock price and stockholders’ wealth are unaffected. c. False. The sensitivity of equity returns to business risk, and therefore the cost of equity, increase with leverage even without a change in the risk of financial distress. d. True. 2. While the costs of both debt and equity increase, the weight applied to debt in the cost of capital formula also increases. Applying
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instruments to hedge against risk, and offer advice and recommendations as required by the scenario in the question. It is also equally important that students understand why corporations manage risk in theory and in practice, because risk management costs money but does it actually add more value to a corporation? This article explores the circumstances where the management of risk may lead to an increase in the value of a corporation. Risk, in this context, refers to the volatility of returns (both
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recommending Nike as a “Strong Buy” and others recommending a “Hold.” In case 13, Nike Inc.: Cost of Capital, I am acting as a portfolio manager to estimate Nike’s cost of capital to determine whether the stock is overvalued or undervalued. II. Alternative Solutions • Dividend Growth Model (DGM) see appendix for calculations • Capital Asset Pricing Model (CAPM) see appendix for calculations • Weighted Average Cost of Capital (WACC) see appendix for calculations III. Analysis of the Alternatives
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M&M Proposition 1 The Modigliani-Miller theorem forms the basis of modern thinking on capital structure. The theorem states that under a certain market price process, in the absence of taxes, bankruptcy cists, agency costs and asymmetric information, an in an efficient market, the value of a firm is unaffected by how the firm is financed. Whether the firm’s capital is raised by issuing stock or selling debt does not affect the value of the firm. This theory is also referred to as the capital
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values. Weighted Average Cost of Capital and Discounting of Terminal Values However, the weighted average cost of capital represents the overall cost of financing the company’s operations and this value represents the returns required by the equity holders and the returns required by the debt holders. In case of AirThread, the cost of equity would be calculated using the average returns offered by the market for an equity share with similar characteristics to the equity share of AirThread, further
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