Table of Contents
1.0 OVERVIEW OF COST OF CAPITAL 2
2.0 COST OF LONG-TERM DEBT 3
2.1 How to Calculate Before Tax Cost of Debt and After-tax cost of debt. 4
3.0 COMMON STOCK 6
4.0 COST OF PREFERRED STOCK 8
4.1 Characteristic of preferred stock 8
5.0 WEIGHTED AVERAGE COST OF CAPITAL 11
6.0 CONCLUSION 14
1.0 OVERVIEW OF COST OF CAPITAL
Cost of capital is the rate of return when a firm earn on the projects invest to maintain the market value of its stock. The cost of capital depends on the how the financial used. Its means they used cost of equity which is business is finance through equity or cost of debt which is finance through debt. Many companies used these two combinations to finance their business. Their overall cost
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Before-Tax Cost of Debt
The way to calculate before-tax cost of debt is first, we have to divide the company’s effective rate to convert to decimal places by 100. For example, the company pays 10 percent (10%) in tax, so divide the amount to 0.10. Second, we need to subtract the tax rate expressed as a decimal from 1.00. For example, subtract 0.10 from 1.00 to get 0.90. And last, using the result of 0.90 and divide by the company’s after-tax cost of debt to calculate company’s before-tax cost of debt. In this example, if the company's after tax cost of debt equals $830,000, divide $830,000 by 0.90 to find a before-tax cost of debt of $922,222.22.
In this world, there’s several of method to calculate the cost of debt. One of them is focus on the yield to maturity (YTM), since YTM is very needed in the market of demand. The function of YTM is company or organization can measure debt of an appropriate maturity with assume the YTM on this debt will be company cost.
Equation: Before-Tax Cost of Debt
Component Cost of Debt =
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Its was a quite difficult to estimate the cost related to issuing the common stock. This is because the nature of the cash flow streams to common shareholders. As a result, they receive their return in the term of dividend and the dividend they received is not fixed as a dividend is at the discretion of the board of director.
There are two methods or techniques to estimate the cost of common stock; the dividend valuation model and the capital asset pricing model.
1. Using the dividend valuation model:
The dividend valuation model tells that the stock price of share is the present value of all its future cash dividends (assume to grow at a constatnt rate) that is expected to provide over an infinite time horozon. P0= D1 rs – g
Where D1 is next period’s dividends, g is the growth rate of dividend per year, and P is the current stock pice per share. The expression for the cost of common stock equity: rs = _D1_ + g
Earlier 2002, the stock price of Agnico-Eagle Mines sharply decreased by $1 finally closed at $13.89. This price has reached one of the lowest level, from the company's historical perspective. As a professional equity portfolio manager, who has a large number of AEM stocks on hand. Acker and his team are necessary to find a proper way to estimated the fair value of AEM as well as its equity. Discounted Cash Flow (DCF) has been chosen to do this job. The theory behind DCF valuation approach is that the firm's value can be estimated by using the expected future free cash flow discounted by an appropriate discounted rate (Koller etc 2005). However several assumptions need to be clearly examined within this approach. The following sections are showing the process of DCF step by step.
DCF model could be the basic valuation, other valuing method, like Market Multiples should be considered to make result more accurate.
First of all an analysis of the packaging machine investment’s hurdle rate is required. I will use comparable firm parameters approach to figure out the hurdle rate (WACC) of the firm using the information provided in Exhibit 5. The cost of debt should be calculated using the bond information given in footnote 2 of case under Exhibit 2. The cost of equity should be calculated using the Capital Asset Pricing Model.
We defined several criteria to determine our choice – return, risks and other quantitative and qualitative factors. Targeting a debt ratio of 40% will maximize the firm’s value. A higher earning’s per share and dividends per share will lead to a higher stock price in the future. Due to leveraging, return on equity is higher because debt is the major source of financing capital expenditures. To maintain the 40% debt ratio, no equity issues will be declared until 1985. DuPont will be financing the needed funds by debt. For 1986 onwards, minimum equity funds will be issued. It will be timed to take advantage of favorable market condition. The rest of the financing required will be acquired by issuing debt.
a. The cost of debt is the money company has to pay for using the funds. In our case, annual cost of debt is kd: kd/2 = r = 5.0%. kd/2 = (47.5 + [1000-891] / 30) / ((2*891 + 1000) / 3) = 5.5% We have to multiply t...
In assessing Du Pont’s capital structure after the Conoco merger that significantly increased the company’s debt to equity ratio, an analyst must look at all benefits and drawbacks of a high debt ratio. The main reason why Du Pont ended up with a high debt to equity ratio after acquiring Conoco was due to the timing and price at which they bought Conoco. Du Pont ended up buying the firm at its peak, just before coal and oil prices started to fall and at a time when economic recession hurt the chemical industry of Du Pont. The additional response from analysts and Du Pont stockholders also forced Du Pont to think twice about their new expansion. The thought of bringing the debt ratio back to 25% was brought on by the fact that the company saw that high levels of capital spending were vital to the success of the firm and that high debt levels may put them at higher risk for defaulting.
The final model used to compute the cost of capital was the earning capitalization model. The problem with this model is that it does not take into consideration the growth of the company. Therefore we chose to reject this calculation. The earnings capitalization model calculations were found this way:
(CAPM). Other methods, such as the dividend-discount model (DDM) and the earnings-capitalization ratio, can be used to estimate the cost of equity. In my opinion, however, the CAPM is the superior method.
During the term of the contract with a known dividend yield, an equity forward contract value at time t is equal to the present value of the difference between the price agreed to pay for the asset at time T, F (0, T), and the value of the asset which acquire under the contract at time T, less the present value of the known dividends payable. In addition, during the term of the contract, if the equities have a known cash flow that leads to equity forward contract price is equal to the spot price, less the present value of the known cash flow, added at the appropriate rate of interest for the time to maturity date.
In SIVMED’s case, based on the definition of WACC, all capital bases should be included in its WACC. These include its common stock, preferred stock, bonds and long-term borrowings. In addition to being able to compute for the costs of capital, the WACC also determines how much interest SIVMED has to pay for all its activities. The value of the firm’s stock, which we want to maximize, depends of the after-tax cash flow. Hence, after-tax values for WACC are also needed. Furthermore, cost of capital is used to determine the cost of each debt, stock or common equity. Being able to analyze these will be essential into deciding what and how new capital should be acquired. Hence, the present marginal costs are ideally more essential than historical costs.
residual earnings growth from 2009 to 2010, and then dividing this figure by the difference between the cost of equity and the residual growth.
During the last 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’s cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task.
Theoretically, it is the foundation of simpleness and reasoning for stock valuation as any cash payoff from company is entirely in form of dividends. However, in practice, this model require further hypothesis on company’ dividend payments, future interest rate and growth pattern. Therefore, it is assumed that the DDM model merely applies to evaluate roughly minor proportion of the value of company’ share price. Specifically, the JB HI-FI value obtained from the DDM is 30.65 higher than their actual currently trading share price 24.1; a different of 6.55, and then the stock is undervalued. Consequently, DMM is not applicable for stock price valuation in case of JB HI-FI since it is not an individual approach of stock
The basic earnings per ordinary share in 2016 is RM19.14 and RM14.30 in 2015. This shows that the ordinary share had been increased RM4.84 compare to 2016 based on 2015. In the other hand, this company had declared a first interim single-tier dividend of 10 sen per ordinary share amounting to RM22.88 million in respect of the financial year ended 31 December 2016. They sold their ordinary shares of RM400,000,000 units of RM0.50 per each in 2016 and RM200,000,000 units of RM0.50 per each in 2015 to their shareholders. It is increased from 2015 to 2016 with 200,000,000 units. The other investments that available for sale is RM1000 same as in 2015 and 2016.
The ratios returns on investment (ROI) and return on equity (ROE) are two of the most popular measure of profitability of a company and, along with the P/E ratio, have the most significant value of any of the ratios. The DuPont Model expands on the ROI calculation by inserting sales and it's relationship to the companies' generation of profits and utilization of assets into the calculation. Additional profitability ratios include the price earnings ratio (P/E), the dividend payout and the dividend yield. The price earnings ratio helps to indicate to investor how expensive the shares of common stock of a firm are. Dividend yield is part of the stockholders ROI and is represented by the annual cash dividend. Dividend yields have historically been between 3% to 6% for common stock and 5% to 8% for preferred stock. Dividend payout ratio shows the proportion of the earnings paid to common shareholders. Dividend payout for manufacturing companies range from 30% to 50%, but can vary widely.