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cost analysis of NESTLE company. project reportFull description
Cost of Capital & Capital structureFull description
FIN100: Cost of Capital and Long-term Financial Policy Cost of Capital o o
o o
It refers to the cost of using long-term financing money. It is the expected returns of inestments !ithout impairing the principal alue of money inested. It is the return that inestors demand for a gien leel of ris". It seres as a #enchmar" in ealuating proposed engagements.
Cost of capital according to sources: o o o o
Cost of debt; Cost of preference share; Cost of ordinary share; and Cost of Retained Earnings;
Weighted Average Cost of Capital (WACC) o
o
It is the minimum return a company needs to satisfy all of its inestors$ including stoc"holders$ #ondholders$ and preferred stoc"holders. %his is the cost of capital for the firm as !hole$ and it can #e interpreted as the re&uired return on the oerall firm. Required Rate of Return vs. Cost of Capital
Cost of Coon Equity o o
It is the return that e&uity inestors re&uire on their inestment on a firm. 'pproaches 'pproaches in computing computing cost cost of e&uity( e&uity( !ividend "ro#th $odel (!"$) Approach o Capital Asset %ricing $odel (CA%$) o
!ividend "ro#th $odel (!"$)
o
)ometimes referred to as the *ordon *ro!th +odel$ Cost of e&uity is determined #y getting the sum of the yield rate and the gro!th rate. Cost of e&uity is computed as follo!s:
o
,here:
o
• • •
CC / Cost of Common &uity +PP) net / +ar"et Price per share$ net of flotation costs *2 / *ro!th 2ate
&lotation Cost o
%hese are costs incurred in issuing the shares of stoc" in the capital mar"et such as under!riting fees$ agency costs$ printing$ adertising$ and taxes.
FIN100: Cost of Capital and Long-term Financial Policy Advantages and !isadvantages of !"$
Capital Asset %ricing $odel o
o
%his approach computes the cost of common e&uity #y the mar"et rate composed of ris"free rate and the ad3usted ris"-premium rate. Cost of common e&uity is computed as follo!s:
,here: •
CC / Cost of Common &uity
•
2F / 2is"-free rate
•
'd3usted 2is" Premium 2ate / 4 +ar"et 2ate 5 2F
Eleents of CA%$ o
Ris'free rate o
o
Ris' %reiu Rate o
o
2epresents the #usiness ris" attendant to a gien pro3ect or underta"ing.
Adusted Ris'preiu o
o
2epresents the rate of return in a relatiely ris"-free or ris"less inestments.
It is the #asic ris"-premium ad3usted #y a company6s #eta coefficient.
*eta coefficient (+) o
o
It is a measure that descri#es the ris" of an inestment relatie to other inestments in general. It is the correlation #et!een the olatility price ariation of the indiidual stoc" price !ith the composite price of the stoc" mar"et.
FIN100: Cost of Capital and Long-term Financial Policy Advantages and !isadvantages of CA%$
Cost of !ebt o
It is the return a firm6s creditors demand on ne! #orro!ings.
o
It is computed as follo!s:
,here: •
I2 / ffectie Interest 2ate
•
tr / %ax 2ate
r$ alternatiely$ it can also #e computed as follo!s
,here: +ar"et alue is net of all flotation costs
Cost of %reference Equity o
o
)ometimes referred to as the preferred stoc" yield rate$ it is the return that preference e&uity inestors re&uire on their inestment on a firm. It is computed as follo!s:
,here: •
CP / Cost of Preference &uity
•
7P) / 7iidends per share
•
+PP) / mar"et price per share $ net of floatation cost
FIN100: Cost of Capital and Long-term Financial Policy ,he Weighted Average Cost of Capital o
o
o
'fter computing the cost of capital from different sources$ a firm must compute for its !eighted aerage Cost of capital to compute for the oerall re&uired rate of return. %his is done #y assigning !eight to each of the sources depending on its capital structure or capital mix. It should #e noted that in the computation$ the correct !ay to proceed is to use the mar"et alues of the de#t and the e&uity.
,rading -n Equity o
o
o
It is the reduction of the !eighted cost of capital #y strategically #alancing the proportional mix of de#t and o!ner6s e&uity. 'n intelligent !ay to do this is #y increasing the proportional mix of long-term de#t oer other sources of capital. %his is #ecause de#t has the lo!est cost of capital. If a #usiness uses more de#t to finance its operations$ !e can say that a #usiness is highly leeraged. It means more de#t$ lo!er cost if capital$ higher exposure to the ris" of insolency$ and expectedly$ higher return on common e&uity.
