WACC should be decreased by leveraging, showing effects of an overall reduction in the cost of capital; thus optimising value and capital structure of the firm.source??? The WACC remaining virtually the same shows that equity and debt holders demand virtually the same amount of return after recapitalization. Therefore, recapitalization is a good move.
WACC means weighted average cost of capital. The company has to bear on average a cost of 10.91 % to finance its operations. However it is significant to note that cost of equity is really high as compared to cost of debt this makes SanDisk a less risky company in respect of debt. But SanDisk can use leverage and geared up its operations by injecting debt as fresh blood in
The report that follows endeavors to determine an appropriate Weighted Average Cost of Capital (WACC) for the H. J. Heinz Company at the end of the 2010 fiscal year. Further, the report attempts to provide reasonable explanations for the decisions and assumptions that were made throughout the required calculations, specifically around the firm’s capital structure, cost of debt and cost of equity. Finally, the report offers an opinion on the validity of the derived WACC figure and the role it could potentially play in the decision making process at H. J. Heinz.
William Wrigley Jr. Company is exploring whether it is optimal to recapitalise with taking on $3 billion of debt. Three options are revised; borrow and repurchase shares, dividend payouts or continue to function with full equity. Debt will provide a tax shield of $1.2 billion given the tax rate is 40%, this should increase the market share price to $61.53 per share. The viable method for the company is to utilize this debt to repurchase shares. The will not only increase Wrigley’s market value, via the debt shield, but also signal to market that management believes Wrigley’s is undervalued, something the dividend payment won’t achieve.
WACC is the acronym of “Weighted Average Cost of Capital” which calculates the cost of a company capital from all sources, common stock, preferred stock, long terms debts bonds ect.., WACC increases respectively when the rate of return on equity and beta increases which means that the increase of the WACC will indicate the increase in risk and decrease in valuation, and on the other hand a low WACC will show that the company gets its capital cheap, in fact WACC it is known as a mixture of cheap debt and expensive equity.
Issuing 3 billion dollars of new debt to pay dividends should not have any effect on the voting control of the Wrigley family. Using that money to buy back shares will have an effect on the voting right of the family. When shares are repurchased they are put in the company treasury and are no longer outstanding. Then the Wrigley family’s percent of outstanding shares would rise giving them more voting control. They also have 58% if the outstanding shares of the Class B shares which have a 10 to 1 voting advantage over the common share class. These shares are not affected by the buyback.
If the company chooses to pay a dividend, the Wd will be 18.63% (3,000,000/ (13,103,000+3,000,000)*100%), the WACC will be 10.32% (18.63% (1-40%)*13%+81.37%*10.9%). If the company chooses to repurchase the stock, the WD will be 22.89% (3,000,000/13,103,000), the WACC will be 10.19% (22.89% (1-40%)*13%+77.1%*10.9%). Both 10.32% and 10.19% are lower than the WACC before recapitalization, which indicates that after the recapitalization the company will have a lower minimum rate of return for the company that it needs to earn on its investments to maintain its wealth.
This report examines the impact a $3 billion bond issue will have on the value of the William Wrigley Jr. Company. When analysing its various impacts, the expectations that arise as a result of the leveraged recapitalisation include an increase in the share price & cost of capital and reduced earnings per share. In essence, the potential benefits of a $3 billion bond issue are outweighed by the costs. Other potential impacts were considered and it was expected that the debt issue would lead to an increased agency cost of debt while voting control was not expected to change. The signal of
Rational investors are likely to infer a higher firm value from a higher debt level. Thus, these investors are likely to bid up a firm’s stock price after the firm has issued debt in order to buy back equity. We say that investors view debt as a signal of firm value. Moreover, corporations can
the financial condition of company will affect their investment directions such as the project with product quality enhancement. So the incentives of investing can be affected by company financial conditions. In addition, the product and input market interactions also can affect company financial condition such as how the firm dealing with product recall and recovering from the recall. Maksimovic and Titman (1991) also argued that debt financing will affect their incentive in investing high quality or enhancement product because the debt financing make company more pressure on cash flow and cutting cost for getting short term profit and in case of bankruptcy. Titman (1984) also mentioned that the relationship between firms and suppliers
Nike has a many different segments, 62% of revenue is the main segment which includes 30% in apparel, design for sports activities. Nike sells 4.5% of non-Nike brand, which adds tiny portion of Nike’s revenue. The cost of debt RD, according to the Joanna Cohen’s calculation, she calculates the company’s cost of debt based on previous data, which will not show the Nike’s current cost of debt. According to the financial cost theory, the weighted- average cost of capital (WACC), must reflect the future interest rate because cost of capital based on book value. Cohen did not use the market value for the debt and equity weights; the reason for using the market value is to estimate the future raise of the capital in the company.
Some variables have been tested by some researchers; nevertheless, there has not been significant emphasis on variables such as “the effect of market-to-book equity ratio on leverage”.
In their 1st proposition they considered that the firm’s value is not depending on its capital structure. The 2nd proposition held that financial leverage incrrases to expected EPS keeping the share price constantly. The 3rd proposition concluded that an investment finance by common stock is advantageous to the outstanding shareholders only in the case that it yield exceed the capitalization rate.