Financial Management Assignment - Estimation of Cost of Capital
1. Introduction -
In this section you are supposed to introduce the topic of the assignment; the cost of capital-the concept, its importance, various forms and their applications.
2. Introduction to the company -
Origin, growth and current business profile of the company in brief.
3. Sources of Capital of the company -
The Current composition
Trends - use at least last 5 years data
Your observations of the capital structure of the firm; whether the capital structure of the firm has been relatively fixed in terms of composition or it has been changing over time. Analyze the direction and the reasons for the change.
Also, analyze whether the capital structure of the firm is comparable to the other firms in the industry- those who engage in similar line of business.
See whether the firm is using short term borrowings to finance the fixed assets - In that case current liabilities should be greater than current assets. Is it a temporary phenomenon? If it is not a temporary one and materially significant, it is reasonable to take the part of the short term borrowings used to finance fixed assets to the cost of capital estimation.
4. The Estimation of the Cost of Capital -
a. The estimation of the Cost of equity: You may use both CAPM approach as well as dividend discounted model approach.
b. The estimation of the cost of Preference shares, if available.
c. The estimation of the cost of marketable debt - debentures, if any.
d. The estimation of the cost of the other borrowings.
e. The estimation of the WACC or the overall cost of capital.
f. The application of the WACC.
Can the company use the WACC as its required rate of return across all projects - this depends on whether the company is into one line of business or into multiple lines of businesses. If the company is into multiple lines of businesses, how should the company find the required rate of return for different projects?
5. Can the company reduce its WACC by changing the composition of its capital structure?
In that case how do you propose to change the capital structure of the firm?