1) The WACC is basically computed by the sum of multiplying the costs per component to its respective proportional weight (how much that company uses a certain cost of capital) [See Appendix 1]. As financial management is focused on the maximization of the stock price, an optimal structure of costs based on these three factors is needed.
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.
2)
a. SIVMED’s cost of debt is at 6.6% [See Appendix 2a]
b. Yes, flotations should be part of the calculation of debt cost. This is because Flotation costs are typically included in the component of debt calculation as a part of calculating the nominal rate of the debt’ cost, which cover both underwriting spread and the costs paid by the issuing company.
c. The EAR (6.6%) can deal with debts of different payment frequencies. Nonetheless, nominal rates should be used because the total costs, which are naturally small on public debt issues, decrease the net proceeds from the sale.
d. Coupon rates differ from a 15-year bonds and 30-year bonds because we consider the risk of the bond. Usually, the longer the time for maturity, naturally, the higher the risk, hence, generally, the higher cost of debt. Thus, the estimate is not valid. To make it more valid, though, we need to adjust the yield curve calculated using the 15-year bond to a calculation using a 30-year bond.
e. A way to calculate the cost of debt when the outstanding debt has not been traded is to use a synthetic rating based upon the company’s financial ratios (ie the interest coverage ratio). By getting a default spread based on the ratio and adding the risk-free rate, an updated pre-tax cost of debt estimate is going to surface.
f. It would matter because a callable bond, a bond which can be bought back by the issuer before its maturity, can reduce the cost of debt when the interest rate decreases.
The purpose of financial measurement in healthcare is to provide the community with the services it needs, at a clinically acceptable level of quality, at a publicly responsive level of amenity, at the least possible cost. This is done by providing healthcare finance managers with accounting and finance information to help accomplish the purpose of the organization (Nowicki, 2015). When making accounting decisions about budgeting and inventory control, an understanding of economics, statistics, and operations research is needed. Major Financial Measures
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
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.
Jen, F, Choi, D, and Lee, S. (1997). Some Evidence on Why Companies Use Convertible Bonds. Journal of Applied Corporate Finance. Retrieved on June 12, 2006 from the World Wide Web at: http://www.blackwell-synergy.com/links/doi/10.1111/j.1745-6622.1997.tb00124.x.
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%?
The consistent high spending of capital equipment is the first reason why one would recommend reducing the debt to equity ratio. A company with higher levels of debt is less flexible in being able to adjust to new market demands and conditions that require the company to make new products or respond to competition. Looking at the pecking order of financing, issuing new shares to fund capital investing is the last resort and a company that has high levels of debt, must move to the equity side to avoid the risk of bankruptcy. Defaulting on loans occur when increased costs or bad economic conditions lead the firm to have lower net income than the payments on loans. The risk of defaulting on loans and the direct and indirect cost related to defaulting lead firms to prefer lower levels of debt. The financial distress caused by additional leverage can lead to lower cash flows available to all investors, lower than if the firm was financed by equity only. Additionally, the high debt ratio that Du Pont incurred also led to them dropping from a AAA bond rating to a AA bond Rating. Although the likelihood of not being able to acquire loans would be minimal, there are increased interest costs with having a lower bond rating. The lower bond rating signals to investors that the firm is more likely to default than if it had a higher (AAA) bond rating.
Why would HCA want to take on a debt ratio of 86% (See Case Exhibit 1)?
A bond is debt to whoever sells the bond to an inventor. If you buy an IBM bond, you are loaning money ($1000) to IBM instead of a bank loaning money to them. Just like a bank, you are going to charge IBM interest on your money, as well as a return of principle when the loan is due (ten years later). The company does not go to the bank to borrow the money, because the bank will rate the company as a high risk company. Hence, banks are really tight with their money. High yields bond investment relies on an credit analysis in that it concentrates on issuer fundamentals, and a "bottom-up" process. It focuses more on "downside risk default and the unique characteristics of the issuer. In a portfolio of high yield bonds, they are diversified by industry group and issue type. Due to the high minimum size of bond trades, most individual investors are best advised to invest through high yield mutual funds.
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:
Apple’s debt to equity ratio is not very high compared to the industry average of 2.23. The Debt to Equity Ratio of 2014 is 1.08, in which the normal ratio should be less than 1. This ratio of 1.08 shows that the company is financing more assets with debt than equity. In spite
Do not use coupon rate on firm’s existing debt as pre tax cost of debt
The debt used to acquire Salomon has been an important issue for the finances of the company. Although financially storng and unlikely to default, the company needs to look into reducing its debt to increase its profitability.