Capital Structure

Case Study 1 You work in Walt Disney Company's corporate finance and treasury department and have just been assigned to the team estimating later today. You quickly realize that the information you need is readily available online. 1) Go to http://finance.yahoo.com. under " Market Summary," you will find the yield to maturity for the ten year treasury bond listed as "10 Yr Bond (%)." Collect this number as your risk-free rate. 2) In the box next to the "Get Quotes" button, type Walt Disney's ticker symbol (DIS) and click search. Once you see the basic information for Disney, find and click "Key Statistics" on the left side of the screen. From the key statistics. collect Disney's market capitalization (its market value of equity), enterprise value (market value equity + net debt), cash and beta. 3) To get Disney's cost of debt and the market value of its long term debt, you will need the price and yield to maturity on the firm's existing long term bonds. Go to http://www.finra.org, click on Investors and then under "Market Data." click on Bonds. Under " Quick Bond Search, click"Corporate," type Disney's ticker symbol (DIS). and click search. A list of Disney's outstanding bond issues will appear. Assume that Disney's policy is to use the yield to maturity on non callable ten year obligations as its cost of debt, Find the non-callable bond issue that is as close to ten years from maturity as possible. (Hint: You will see a column titled "Callable": make sure the issue you choose has "NO" in this column.) You may have to choose a bond issued by one of its subsidiaries, like ABC. Find the yield to maturity for your chosen bond issue (it is in the column titled "Yield") and enter that yield as your pre tax cost of debt into your spreadsheet. Next, copy and paste the date in the entire table into Excel. 4) You now have the price for each bond issue, but you need to know the size of the issue. Returning to the Web page, go to the row of the bond you chose and click the Issuer Name in the first column (this will either be Walt Disney Company or ABC or another subsidiary). This brings up a Web page with all of information about the bond issue. Scroll down until you find "Amount Outstanding" on the right side. Nothing that this amount is quoted in thousands of dollars (eg., $60,000 means $60 million = $60,000,000) , record the issue amount in the appropriate row of your spreadsheet. Repeat this step for all of the bond issues. 5) The price of each bond issue in your spreadsheet is reported as a percentage of the bond's par value. For example, 104.50 means that the bond issue is trading at 104.5% of its par value. You can calculate the market value of each bond issue by multiplying the amount outstanding by (Price ÷100). Do so for each issue and calculate the total of all the bond issues. This is the market value of Disney's debt. Required: a. Compute the weights for Disney's equity and debt based on the market value of equity and Disney's market value of debt, computed in step 5 b. Calculate Disney's cost of equity capital using the CAPM, the risk free rate you collected in step 1, and market premium risk premium of 5%. c. Assuming that Disney has a tax rate of 35%, calculate its effective cost of debt capital. d. Calculate Disney's WACC. e. Calculate Disney's net Debt by subtracting its cash (collected in step 2 from its debt. Recalculate the weights for the WACC using the market value of equity, net debt and enterprise value. Recalculate Disney's WACC using the weights based on the net debt. How much does it change? f. How confident are you of your estimate? Which implicit assumptions did you make during you data collection efforts? Case Study 2 You have joined Zurich Pvt. Ltd as a Finance manager. You are given the following information: Zurich Pvt Ltd. is a diversified manufacturing firm dealing with electrical appliances. In 2012, the firm reported an operating income of Rs. 857.60 million and faced a tax rate of 35% on income. The firm had a book value of equity is Rs. 4068.3 million and book value of debt of Rs.1567.83 million at the end of 2011.The management of the firm is expecting a stable growth at a rate of 5% annually. You are aware that the risk free rate is 9% and the company operates in a risk premium of 7.5%. You have been informed that the beta for the company has averaged around 1.2. At the same time the after tax cost of debt is 11%. Case Questions: On the basis of the above mentioned information you as a finance manager are asked to provide the following : • Estimate the firms return on capital. • What would be the reinvestment rate of the firm? • What is the cost of equity under which Zurich is operating? • What is the cost of capital? • What is the expected free cash flow to the firm? • What is the value of the operating assets of firm?

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