Advantages And Disadvantages Of The Equity Method

Assumptions need to be made for the Cost of Equity. We used the corporate rate of 11.766%

Barb Williams and Rick Thomas, while attending an executive education course at a well-known business school, came across a case which involved calculating the cost of capital for Telus Corporation (Telus). Basic data such as the Balance Sheet, Income Statement, Data on Telus’ Common Stock, Market Index, and the Average Annual Returns in North American Capital Markets were provided. In order to calculate Telus’ cost of capital we need to calculate the company’s Cost of Equity, Cost of Debt, and Tax Rate along with their weighted cost and then apply these to the Weighted

We use Capital Asset Pricing Model (CAPM) approach to calculate the cost of equity. The formula of CAPM is re = rf + β × (E[RMkt] – rf).

E. Cindy and Rob estimate that the market value of the common equity in the venture is $900,000 at the end of 2010. The market values of interest-bearing debt are judged to be the same as the recorded book values at the end of 2010. Estimate the market value-based weighted average cost of capital for Castillo Products.

The most obvious reason for the difference between the market value of equity and the book value of equity is the inability to record certain intangible assets such as brand value, customer loyalty, and perhaps most importantly, human capital. These intangible assets are likely to provide tremendous earnings growth in the future which determines the company’s market value. Notice also that the company’s choice of conservative accounting policies has the effect of depressing the company’s book value of equity.

Solution – QUESTION 2 (written by Asher Curtis) - 10 Marks Suggestions only: 1. (3 marks for identifying the three dimensions) Applications of cost and equity differ on three dimensions. First, the treatment of dividends, is written against the investment account (Equity) or recognised as revenue (Cost). Second, the treatment of profits reported by the associated entity and the ammortisation of goodwill (the difference in the cost paid and the fair value of the net assets acquired) are not recognised when applying the cost method. The only case where net profit is not affected by choice of the method is where there is no goodwill (cost = fair value of net assets acquired) and the firm pays out all of its profit as dividends. Any of the following alternatives provide examples (2 marks for any of the following): a. The case for a profitable company that pays less than 100% profits out as dividends: The net value of the investment increases under the equity method, which will be more than cost unless the investment is revalued. b. The case for a loss company that pays no dividends: Unless the investment is subject to a recoverable amount test, application of the equity method

Prompt: Once you have read the article “Comparing the Accuracy and Explainability of Dividend, Free Cash Flow, and Abnormal Earnings Equity Value Estimates” and Chapters 6 and 7 of your text, review and complete the questions below. Use the article and your text to inform your responses to the questions below.

There is a number of advantages by using the mixed measurement approach to measure assets and liabilities. For example, a mixed measurement approach provides investors with better information for evaluating Woolworths. Refer to a survey conducted by PricewaterhouseCoopers, most of the investors favor the accounting information using mixed measurement approach. They are interested in the information about longer lived instruments measured by amortized

Another problematic issue is that the accounting rate of return can not be used to compute the cost of equity because normally accounting rate of return is in book value rather than market value. The value of the stock will fluctuate greatly from year to year while the book value does not indicate any risk or future cash flows at all, so it is crucial to calculate the cost of equity by using market value.

It is important to know the proper technique and method of valuing a company because different people may have different ways of assessing the value; it is also important in understanding the bank’s method of appraising and valuing a company or business

Information based on accrual accounting has historically and empirically provided a better indication of a company’s ability to generate cash flows than information gathered under the cash method. If there is not inter-period allocation, then the information is not as meaningful and will result in a mismatching of economic benefits

To find the cost of equity we used the formula rs = rRF + beta*MRP in which rRF2002 = 5.86% and the Market Risk Premium (MRP) = 5% as calculated by the Southwest Airlines finance department. We then calculated the beta for Southwest Airlines based on a regression analysis of five-year monthly returns on Southwest stock from January 1997 to January 2002, compared with the S&P 500 returns over the same period. This regression analysis indicated that Beta = .2219. Therefore,

a. What risk-free rate and risk premium did you use to calculate the cost of equity?

Cost of Equity is the return that stockholders require for a company. A company’s cost of equity represents the compensation that the market demands in exchange for owning the assets and bearing the risk of ownership. Based on capital markets the cost of equity varies in direct relation to the assumed risk in that specific market. The distinctive of the firm is the sensitivity to market risk (β) which depends on everything from management to its business and capital structure. Therefore past performances and present conditions have a direct effect on the overall value. Applying calculations at a divisional level allows specified markets to be analysis based on present market conditions for that service or product. The formula used to calculate Cost of Equity is:

Other methods not considered are the Book Value Method and Economic Method. Book Value Method does not take in to consideration the market value of the company. Eskimo Pie true value is based on the name of the product and not the historical value of assets. Eskimo Pie generates high cash and does not need to invest in fixed assets to create growth.