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Capital structure case studies
Capital Structure Decisions
Essay on capital structure
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1. What specific items of capital should be included in the SIVMED’s WACC? Should before-tax or after-tax values be included? Should historical or new values be used? Why? Answer: WACC covers computation of SIVMED’s cost of capital in which each category of capital is proportionately weighted. All capital basis - common stock, preferred stock, bonds or any other long-term borrowings – should be listed under SIVMED’s WACC. We determine WACC by multiplying the cost of the corresponding capital component by its proportional weight and then adding: where: Re is a cost of equity Rd is a cost of debt E is a market value of the firm's equity D is a market value of the firm's debt V equals E + D E/V is a proportion of financing that is equity D/V is a proportion of financing that is debt Tc is a corporate tax rate Broadly speaking, SIVMED’s assets are financed by the choice of debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, SIVMED can determine how much interest the company has to pay for every dollar it uses. Shareholders are interested into cash flows available to them, after corporate taxes have been paid. Consequently, we have to use After-Tax WACC. The cost of capital is used above all to make decisions that involve getting new capital. Hence, the applicable component costs are present marginal costs but not than historical costs. 2. What is your estimate of SIVMED’s cost of 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... ... middle of paper ... ... value, however, depreciation affects such values as operating profit and value of the company’s assets. If the depreciation is ignored, the Net Income calculations will be erroneous. 10a. Answer: The corporate cost of capital should be used by both division, however, adjustments for market risk, volatility (different industries have different betas), and project’s peculiarities should be made. 11a. Answer: (Book Value WACC) Debt = 61.2 / 155.7 = 39% Preferred Stock = 15 / 155.7 = 10% Common Stock = 79.5 / 170.8 = 51% 2. Answer: (Market Value WACC) Debt = 30% Preferred Stock = 10% Common Stock = 60% C. Answer: Weighted Average Cost of Capital determines marginal cost of issuing new securities to finance projects. Such securities should be issued at market value. Therefore weights allocated to debt and equity in determining WACC should be based on market value.
Financial Accounting Standards Board. (1985). Statement of Financial Accounting Standards No. 86. Norwalk. Retrieved April 7, 2014, from http://www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175820922177&blobheader=application%2Fpdf&blobheadername2=Content-Length&blobheadername1=Content-Disposition&blobheadervalue2=189998&blobheadervalue1=filename%3Dfas86.pdf&blobcol=url
Based on the optimal capital structure analysis, they should pursue as 70% debt proportion, which will give them the lowest cost of capital at 11.58%. Currently Star has no debt in their capital structure, so these new projects should begin to add debt to the company. However, no matter what debt and equity proportions are chosen for each project, the discount rate of 11.58% should be used, as the capital budgeting decisions should be independ...
The estimates of cost of capital for equity 6.14% are making by using the capital asset pricing model (CAPM) to generate forecast of DDM and RIM. This method is defined by the sum of risk free rate plus beta that multiplied with a risk premium. Particularly, the beta, which is a quantitative measure of the volatility of company stock relative to the unstable of the overall market, found in JB HI-FI case at 0.56 (JB HI-FI financial statement 2016). It
Costco Wholesale Corporation was an uncommon type of retailers called wholesale clubs. These clubs differentiated themselves from other retailer by requiring annual membership purchase. Especially in case of Costco, their target market is wealthier clientele of small business owners and middle class shoppers. They are now known as a low cost or discount retailer where they sell products in bulk with limited brands and their own brand. The company is competing with stores like Wal-Mart, SAM’s, BJ’s, and Sears. The case begins with an individual shareholder, Margarita Torres, who first purchased shares in 1997 and who is trying to evaluate the operational performance of the business in order to make a decision rather or not purchase more shares
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.
If we look at the sensitivity analysis, we find as WACC increases, the percentage of US$360M investment in Deltex also increases. When WACC is 5.8%, the percentage of US$360M investment in Deltex is equal to 30% equity of Deltex.
Their poor financial performance required them to use less traditional instruments to obtain financing. The capital acquired supported their growth until they reached a level of profitability in 1978. Subsequently, they continued to increase their net income and the quality of their balance sheet. With continued prospects for growth tempered by some regulatory uncertainty, they need to determine their optimal financial structure for the future. CAPITAL REQUIREMENTS MCI's capital requirements for the next 3 years are x,y and z. See Exhibit A for more information.
DuPont has been known for its low reliance on borrowings. In the 1970’s, the company had to assume a substantial portion of debt of Conoco, a newly acquired company. In 1983, the managers have to decide about the future optimal target debt ratio. Should the company continue to keep about 40% of its assets financed via debt or should it strive to lower its borrowings to 25%?
In order to achieve its goal, the managers of Marriott have developed a financial strategy with 4 main decisions.
WACC is the weighted average return on capital that includes both cost of debt and equity, whereby we discount total cash flows by the appropriate discount rates
a. 1. What sources of capital should be included when you estimate Harry Davis’s weighted average cost of capital (WACC)?
ii. A company borrows £2,000,000 in 1998, with a fixed interest rate of 8%, payable annually for a 5 year period.
Initially, it appears that physical capital maintenance provides information that is more complete with better predictive and confirmatory value by its use of fair value. In actuality, it provides management with a greater ability to manipulate financial information and the wherewithal to do so resulting in decreased decision usefulness, as described by SFAC No. 8, compared to financial capital maintenance. Therefore, financial capital maintenance is the better choice for standards setters.