Cost_Capital FinancialModeling(Example3)_rev.xls

Cost_Capital FinancialModeling(Example3)_rev.xls - Cost of...

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Cost of Capital: Xavier Corporation Peter McIntyre has been appointed as the CFO (Chief Financial Officer) of Xavier Corporation. As he needs to take some important decisions on future investment projects, he is concerned about the firm's Cost of Capital. He has been looking at the firm's financial information and market data in order to figure out the firm's Cost of Capital. Table 1: Book Value Balance Sheet on December 1, 2005 (in Million Dollars) Asset Liabilities and Equity Current 17578.0 Current 1563.6 Deferred Taxes 13391.0 Long-Term 11431.4 Short-term debt 1000.0 Long-Term Debt 10313.8 Equity - Preferred Share 535.0 -Common Equity 2206.0 Total 29009.4 Total 29009.4 Xaxier's bonds are currently selling at \$1021.00 in the market. These are semiannual interest paying bonds, with a coupon rate of 8%. These bonds will mature in 5 years. Xavier's effective tax rate is 35%. Interest rate for the short term debt is 4.6%. The firm has been paying dividends over the last fifteen years. For last five years dividend data please see below: Table 2: Past dividend payments per common share 2001 2002 2003 2004 2005 Dividend (in \$) 0.17 0.18 0.19 0.2 0.21 Xavier's common share is currently selling at \$4.1 in the market. Peter recalls that there are two commonly used methods to calculate the cost of equity - Dividend Growth Model and CAPM. Xavier's preferred share is currently selling at \$96 per share that carries a dividend of \$8 per share. Peter remembers that he needs to use some sort of weighted average to calculate the overall cost of capital. He is confused whether to use Book value weights or Market value weights. Devin comes to his rescue and points that ideally one should use market value weights. Price and number of outstanding securities are given below: Table 4: Price and number of outstanding Securities Security Price (\$) Number of type outstanding securities Bond 1021 10,000,000 Common Stock 4.1 1,000,000,000 Preferred Stock 96 10,000,000 Questions 1 What is the after-tax cost of debt? 2 What is the cost of common equity - (i) using DGM (Dividend Growth Model) (ii) using CAPM? 3 Which method would you prefer - DGM or CAPM? 4 What is the cost of retained earnings? 5 What is the cost of preferred share? 6 What are the weights for different components of cost of capital? 7 What is the Xavier's overall cost of capital? In order to use CAPM, Peter looks for the market data. Relevant information in given below (Table 3 at the end of the page)

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Important Note: In the CAPM (Capital Asset Pricng Model), we need to use the appropriate 'Risk-free rate (Rf)' and 'Market Risk Pre For the simplicity, in the example, we have used the historical monthly average market-risk premium (1.23%); Howe Appropriate 'Risk-free rate (Rf)' and 'Market Risk-Premium (Rm-Rf)' are generally available for a particular econom Strock Return Information (Given) Stock Stock Stock Stock Stock Stock Benchmark Barrick Hanson IBM Nokia Telefonos Xavier Market Index Monthly Returns Dec 2005 -3.50% -0.24% 2.06% 8.76% 8.63% 0.50% 1.08% Nov 2005 -2.37% 4.88% 5.69% 0.51% 9.01% -0.95% 2.37% Oct 2005 1.79% 3.78% -0.12% 1.70% -1.08% 3.49% 3.71% Sep 2005 0.92% -3.49% 12.69% 0.93% 3.14% 7.02% 1.95% Aug 2005 -8.23% 14.36% 1.20% -5.68% 6.76% -3.83% 2.51% Jul 2005 8.68% 3.72% 5.00% 5.20% 3.02% 2.00% 0.18% Jun 2005 4.06% 0.88% 0.78% -2.02% 12.51% 9.98% 0.04% May 2005 -3.30% -0.32% -3.86% -5.67% 6.23% 0.03% 3.10% Apr 2005 0.80% -8.40% -2.61% -5.23% -9.99% -17.69% 1.30% Mar 2005 11.90% 3.92% -0.16% 9.38% -2.17% -3.07% 1.91% Feb 2005 -0.48% 7.12% 2.78% 13.88% 1.21% -2.81% 0.16% Jan 2005 -13.00% 5.15% -1.05% 1.08%
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