Assignment 3-week-3-the cost of capital for goff computer, inc-gm-dr rahul d parikh
The Cost of Capital for Goff Computer, Inc. 1The Cost of Capital for Goff Computer, Inc. Rahul ParikhBUS650: Managerial Finance (MAH1209A) Dr Charles Smith March 18, 2012.
Goff Computer, Inc. 2 The Cost of Capital for Goff Computer, Inc.:1. Most publicly traded corporations are required to submit 10Q (quarterly) and 10K(annual) reports to the SEC detailing their financial operations over the previousquarter or year, respectively. These corporate fillings are available on the SEC Web siteat www.sec.gov. Go to the SEC Web site, follow the “Search for Company Filings” link,the “Companies & Other Filers” link, enter “Dell Computer,” and search for SECfilings made by Dell. Find the most recent 10Q and 10K and download the forms. Lookon the balance sheet to find the book value of debt and the book value of equity. If youlook further down the report, you should find a section titled either “Long-term Debt”or “Long –term Debt and Interest Rate Risk Management” that will list a breakdown ofDell’s long-term debt.Answer:The book value of a companys equity is the same as stockholders equity, which can becomputed by subtracting the total value of liabilities from total assets.(Total Assets) = (Total) Liabilities + Stockholders Equity (book value of equity).Stockholders Equity (book value of equity) = Total Assets –Total Liabilities.The book value of the company’s liabilities and equity was found from the sitehttp://www.sec.gov . I found Dell’s Form 10K, dated January 28, 2011, and snap shot isattached here with. Dell’s Form 10K shows the following:Book value of equity: 10-k:Total Assets =38,599 millions; Total Liabilities = 30,833 (Dell 10-K, January 28, 2011, p.57)Book value of equity = Total Assets –Total Liabilities = $38,599 – $30,833 = $7,766 millions, (Dell 10-K, January 28, 2011, p.57).
Goff Computer, Inc. 3The book value of the company’s liabilities and equity was found from the sitehttp://www.sec.gov . I found Dell’s Form 10q, dated October 28, 2011, and snap shot isattached here with. Dell’s Form 10q showed the following (Note: 10q form also shows dataof Dell 10K dated January 28, 2011.]:Book value of equity: 10-Q:Total Assets =42,043 millions; Total Liabilities = 33,380 (Del 10-Q, October 28, 2011)Book value of equity = Total Assets –Total Liabilities = $42,043 – $33,380 = $8,663 millions, (Dell 10-Q, October 28, 2011).
Goff Computer, Inc. 4Book value of debt: It is labeled in the balance sheet as Shareholders Equity and Liabilities.Book Value of Debt: 10k = $38,599 millions, (Dell 10-K, January 28, 2011, p.57). 10Q = $42,043 millions, (Dell 10-Q, October 28, 2011).Long-term Debt: 10k = $5,146 millions, (Dell 10-K, January 28, 2011, p.57). 10Q = $6,430 millions, (Dell 10-Q, October 28, 2011).2. To estimate the cost of equity for Dell, go to finance.yahoo.com and enter the tickersymbol “Dell.” Follow the various links to find answers to the following questions: Whatis the most recent stock price listed for Dell? What is the market value of equity, ormarket capitalization? How many shares of stock does Dell have outstanding? What isthe beta for Dell? Now go back to finance.yahoo.com and find the bonds link. What isthe yield on 3-month Treasury bills? Using a 7 percent market risk premium, what isthe cost of equity for Dell using the CAPM?Answer: To estimate the cost of equity, I collected various pieces of information datedMarch 4 2012, to calculate the CAPM. The following information, necessary for my
Goff Computer, Inc. 5calculations, was gathered from finance.yahoo.com. The screen shots below show thisinformation.Most recent stock price is: $17.36 (finance.yahoo.com)Market Capitalization: 30.87B (finance.yahoo.com)Shares Outstanding: 1,918 millions (Dell 10-K, January 28, 2011).Dell Beta: 1.39 (finance.yahoo.com)Yield on 3-month Treasury bills: 0.04 (= 4%); (finance.yahoo.com).
Goff Computer, Inc. 8Using a 7% market risk premium, what is the cost of equity for Dell using the CAPM?Capital Asset Pricing Model (CAPM) Rs = RF + β X (RM – RF)Expected return on stock(Rs) == risk-free rate (RF) + Stock beta (β) x Market Risk Premium (RM – RF)= 4% + (1.39 * 7.0%)= 0.04 + (1.39 * .07)= 0.04 + 0.0973= 0.1373= 13.73%Cost of equity for Dell = 13.73%.3. Calculate the industry average beta. Using the industry average beta, what is the costof equity? Does it matter if you use the beta for Dell or the beta for the industry in thiscase?Industry average beta: Below are the top nine competitors in the computer hardwareindustry by market capitalization: Company BetaIBM 0.6HPQ 1.47Dell 1.39CSCO 1.38XRX 1.76STX 2.8AAPL 1.04NCR 1.15EMC 1.17Industrial Average 1.42Beta Industry average = 1.42Cost of equity using industry average beta:Rs = 4%+ (1.42 x 7.0%)
Goff Computer, Inc. 9 = 0.04 + (1.42 * .07) = 0.04 + 0.0994 = 0.1394 = 13.94%Cost of equity = 13.94%Does it matter if you use the beta for Dell or the beta for the industry in this case?It would not matter whether we use beta for Dell or beta for the industry, because allcompanies are not equal to Dell; so there is little difference in the cost of equity. But as Dell’sbeta is very close to average industry beta, I will use the cost of equity using Dell’s beta.4. What is the weighted average cost of debt for Dell using the book value weights andthe market value weights? Does it make a difference in this case if you use book valueweights or market value weights?Bond portfolio: To get the yield to maturity on each of randomly taken four Dell’s bonds, Iwent on March 4, 2012, to the site:http://cxa.marketwatch.com/finra/BondCenter/Watchlist.aspx; and following information wasobtained, which is the snap shot as below:
Goff Computer, Inc. 10 Values from above table, and figures obtained by clicking each bond links were used to calculate the cost of debt for Dell. The weighted average cost of debt for Dell using both the book value and the market value is detailed in following table: Weighted Weighted Percent Market Percent Yield to Book Market Book value of total Quoted value of Maturity values values (millions) (c) price (millions) total(a) (b) (c*b) (a*b)Dell GB 300 0.17 126.580 275.016 0.17 4.723% 0.80% 0.80%Dell GF $600 0.33 104.235 $566.202 0.35 0.842% 0.28% 0.30%Dell GG 500 0.28 118.345 460.530 0.28 2.401% 0.67% 0.67%Dell GH 400 0.22 125.005 322.900 0.20 4.583% 1.01% 0.92%Total $1,800 $1.00 $1,624.65 1.00 2.76% 2.69% Analyzing above table, it seems that weighted average cost of debt using book value, the weights are 2.76 percent, and using market value, the weights are 2.69 percent. It seems irrelevant whether we use book or market values to calculate the cost of debt for Dell, which
Goff Computer, Inc. 11means it would not make a difference whether the book or market values were used becausethey are the approximately the same, and yields almost the same cost of debt.5. You now have all the necessary information to calculate the weighted average cost ofcapital for Dell. Calculate the weighted average cost of capital for Dell using book valueweights and market value weights assuming Dell has a 35 percent marginal tax rate.Which cost of capital number is more relevant?Calculation:Using book value weights, the total value of Dell using 10k annual values is: V = $1,800,000,000 + $7,766,000,000 V = $9,566,000,000So, the WACC based on book value weights using 10k annual values is:WACC = (E/V) x Re + (D/V) x Rd x (1-T)Where:Re = cost of equityRd = cost of debtE = market value of the firms equityD = market value of the firms debtV=E+DE/V = percentage of financing that is equityD/V = percentage of financing that is debtT = corporate tax rateWACC = (0.1373)($ 7.7660/$9.5660) + (.0276)($1.800/$9.5660)(1 – .35) = (0.1373)*(.812) + (0.0276) * (.188) * (.65) = (.112) + (.003)
Goff Computer, Inc. 12WACC = 11.5%Now using the market value weights, the total value of Dell is:V = $1,624,650,000 + $21,728,000,000V = $23,325,600,000WACC based on market value weights is:WACC = (E/V) x Re + (D/V) x Rd x (1-T)WACC = (0.1373) * ($21.728/$23.3256) + (.0269) * ($1.62465/$23.3526) *(1 – .35) = (.128) + (.001)WACC = 12.9%Conclusion: The cost of capital for Dell using market value weights is higher than bookvalue weights because of higher market-to-book ratio for Dell. The market value is morerelevant because it is the actual sale value of the company.6. You used Dell as a representative company to estimate the cost of capital for GCI.What are some of the potential problems with this approach in this situation? Whatimprovements might you suggest?Answer: Using Dell as a representative company to estimate cost of capital, the leadingpotential problem with GCI is that it operates stores for company’s sales, while Dell salesthrough its internet site. This could potentially be one of the risk factor affecting the cost ofcapital. Another factor affecting the cost of capital is that Dell is a fortune 500 company, andis one of the leaders in its industry, so it can access capital being a public company, whileGCI is privately owned company.If I had to suggest improvements, I would advice GCI to go as a public sector company, andsale its products on internet, rather than at stores, just like Dell Inc.
Goff Computer, Inc. 13 References:Apple Inc (AAPL.O), Retrieved March 4, 2012, from http://www.reuters.com/finance/stocks/financialHighlights?symbol=AAPL.OBond Center. US Treasury Bonds Rates Retrieved March 4, 2012, from http://finance.yahoo.com/bondsDell Bonds, Market Data; Retrieved March 4, 2012, from http://cxa.marketwatch.com/finra/BondCenter/SearchResult.aspx?q=DELL.Dell Bonds, Watchlist; Retrieved March 4, 2012, from http://cxa.marketwatch.com/finra/BondCenter/Watchlist.aspxDell Inc. (DELL) Retrieved March 4, 2012, from http://finance.yahoo.com/q?s=Dell&ql=1Dell Inc.s 2011 Form 10-K (January 28, 2011), Retrieved March 4, 2012, http://www.sec.gov/Archives/edgar/data/826083/000095012311025579/d78468e10vk .htmDell Inc.s 2011 Form 10-Q (October 28, 2011), Retrieved March 4, 2012, from http://www.sec.gov/Archives/edgar/data/826083/000082608311000015/dellq3fy1210 q.htmHewlett Packard Co (HPQ.N), Retrieved March 4, 2012, from http://www.reuters.com/finance/stocks/financialHighlights?symbol=HPQ.NInternational Business Machines Corp (IBM.N), Retrieved March 4, 2012, from http://www.reuters.com/finance/stocks/financialHighlights?symbol=IBM.NRoss, S., & Westerfield, R., Jaffe, J., & Jordan, B. (2011), Corporate finance: Core principles and applications (3rd Global ed). Boston, MD: McGraw-Hill Irwin. ISBN: 978-0-07-353068-0.