Essay about Telus: the Cost of Capital

1163 Words Sep 17th, 2008 5 Pages
Telus: The Cost of Capital
Telus needs to calculate the cost of capital from the variety of data given. The cost of capital is determined mostly by how the funds are used rather than where they were obtained from. It relies on the risk of investments Telus involves in, therefore, depending on cost of both equity of debt as described below. Also note that, even though the preferred shares are not attractive to issuers and may not get issued again, it is still on the company’s balance sheet and affect firm’s overall wealth.

PREFFERED SHARES

We assume that Telus maintains a fixed debt to equity ratio and hence, the calculation will include preferred shares. 5.00 percent of cost in the past cannot be used towards final calculation
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Therefore, the cost of common stock is obtained by using the dividends divided by the market price.
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.

Given: price/share: $25; # of shares outstanding: 287,000,000 (in footnotes)
Therefore, market value = 287,000,000 x $25 = $7,175,000,000
Re: 10.04% (as shown below in details)

Dividend Growth Model:
We obtain the growth rate g in the dividend growth model by calculating the geometric average for the last 10 years based on Common DIV/SH.

The approx. growth rate g is 0.30 (1+g)31 = 1.40 g ≈ 0.0509 ≈ 5.09%
Re=D1/Po+g=Do(1+g)/Po + g=(1.4(1+0.0509)/25)+0.0509 = 0.10975
Re ≈ 11.00%

CAPM Model
According to the newspaper, the Rf (risk free-rate) for a long-term Government of Canada Bonds is 5.82%. The RM (return on the market) as the geometric average for Market Index is 10.2%. For the accuracy reason, we chose to use the geometric average for both long-term government bonds and market portfolio.

Re =Rf + β (RM - Rf) = 0.0582 + 0.75 (0.102 – 0.0582) = 0.09105or

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