Winglet Case Study Essay

General speaking, WACC is the rate that a company’s shareholders expect to be paid on average to finance its assets, and it is the overall required return on the firm as a whole. Therefore, company directors often use WACC to determine whether a financial decision is feasible or not. In this case, I will choose 9.38% as discount rate. The reason why I choose 9.38% as discount rate is because the estimated Debt/Equity is 26% under the assumptions by CFO Sheila Dowling, which is most close to 25% of Debt/Equity from the projected WACC schedule. There might be some flaws existing by using WACC as discount rate. As we know, the cost of debt would be raised significantly as the leverage increased. The investment will definitely increase the firm’s current debt. So, the cost of debt would not keep at 7.75%.

The next step was to determine the cost of debt and cost of equity. Case assumptions made by Liedtke of a 40% corporate tax rate, 6% estimated cost of debt, and 20% leverage were used in calculating the cost of debt. The cost of debt was determined to be 3.6% (= Debt*(1-Tax Rate).

Based on the suggestion that the focus should be on market values, compute the weights of debt, preferred stock, and common stock.

The cost of equity was found using CAPM, with the given market risk premium of 5%, a beta of .88, and risk-free rate of 4.03%. The beta was found by running a regression of Southwest’s percent change in stock price versus the S&P 500’s percent change in stock price for two years (June 28, 2000 to June 28, 2002). The risk-free rate was the return on a ten-year treasury note issued on June 28, 2002, according to the U.S. Treasury’s website. The tax rate of 39% was used to account for tax savings from leverage. In order to calculate the firm’s leverage, the market value of equity was found from the price per share on July 24, 2002 (Yahoo Finance) and the shares outstanding on the balance sheet of the July 10-Q report, as shown in Exhibit X. The debt value was approximated at the book value since data could not be found regarding its market value. This analysis resulted in a debt weight of 11.74% and equity weight of 88.26%. The final approximation for the weighted average cost of capital was 8.64%.

WACC= (%of debt) (after-tax cost of debt) + (% of preferred stock)(Cost of preferred stock) + (% of common equity) (Cost of common equity)

WACC = Cost of Debt X proportion of debt + Cost of Preferred Stock X Proportion of preferred stock + Cost of equity X proportion of equity

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

The debt/equity ratio for Boeing is provided in exhibit 10, 0.525, from where we can infer the weights of both debt and equity.

I did not encounter any difficulty to determine WACC. The spreadsheet accompanying this project was helpful as we input all values in them to determine WACC. CVS’s return on capital is 11.08%. CVS generates higher returns on investment than it costs

The Cost of debt is determined by using the average of YTM of the 4 JetBlue debt instruments provided in Exhibit 4. The exact value is 6.91%, and a CAPM cost of equity is determined to be 10.50% using the risk-free rate, market risk premium and comparable beta from Southwest of 1.10. The cost of capital is determined to be 6.90%. Running the DCF analysis, JetBlue is currently valued at $2.7bn. Distributing equity value over the shares outstanding gives a share price of $66.51. This proposed price of the IPO is highly overpriced, considering that the underwriters have priced it within a range of $22-$24.

For this reason, new, or marginal, costs are used in its calculation. WACC is calculated by multiplying the cost of each capital component by its proportional weight and then summing then together. The capital components included in this calculation are a firms after-tax costs of debt, preferred stock, and common stock.

(1- Tax Rate) * E / (E + D) * Cost of Equity + D / (E + D) * Cost of Debt

.5189 for FY 2015, they show that almost half of the remaining assets are acquired by the shareholders. This is similarly projected by the equity ratio. Meanwhile, the debt-to-equity ratio foretells that there is a proportion of 143% total liabilities (for FY 2015) against the shareholder’s equity. The ratio seems high, yet it only shows the value allocation of the total liabilities against the total equity. On the other hand, for FY 2014, the total liabilities and total equity

The debt to equity ratio is a “measure of financial risk provided by showing the amount of assets provided by creditors in relation to the amount provided by stockholders.” (Needles, 2014). Upon analysis of year 2016 annual report, Southwest Gas Holding’s debt to equity for the quarter that ended in 2016 was 0.96 as compared to the quarter that ended 2015 which was 1.0. This is a measure of the financial leverage a company has. This ratio means to me that this company is responsible and uses an equal amount of equity vs debt to pay for their projects. In other words, in 2016, the company matches 96 cents for each dollar given by its stockholders to pay for the assets. The ratio did not change much from last year’s calculation which means for the last two years the balance sheets reflected that the company is investing about the same.

First we need to identify the debt, equity and the firm value, which is equity plus debt. Then we identify the debt cost (rD), which is a pre-tax cost, and then we need to identify the cost of equity (rE). As we can observe in table A, the debt percentage in capital is 60 %, which implies that the equity is 40 %. By dividing the income taxes by the company’s income before taxes, we find that t = 175,9 / 398,9 = 0,44