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78126272 vemba-4-hcm-hb-case7

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78126272 vemba-4-hcm-hb-case7

  1. 1. Nguyen The Cam Hoan Le Tung Bach HB Group-Cohort 4 VEMBA HCM Bus 633Case Study Finance Management Report 2 Case 8: Stephenson Real Estate Recapitalization. I. Case summary and assumptions StephensonReal Estate Companyisa25 yearsoldreal estate development and management company. The company shows continuous profit within the past 18 years. Due to past duress with debt management, the company’s CEO chooses to finance his company with equity only. Currently, the company has 15 million shares outstanding and the last traded price was USD 34.50per share. The company has virtually no debt. The current cost of capital of the company is 12.5%. The company is subject to 40% corporation tax rate. The company is now preparing for a new project which consists of purchasing a tract of land in the southeasternUSA forUSD 95 million.The landthenwill be leased to tenant farmer. Consequently, the lease increases the earnings of Stephenson by USD 23 million on pre-tax basis. The CFO thinks that the company can finance this project using debt structure. As a result, she thinks that an issue of bond with 8% of coupon rate isreasonable.She alsofeelsthata capital structure of 70% of equityand 30% of debt isthe most profitable forthe company.The debtshouldn’tbe more than 30% because it will make the bond carrying lower rating and much higher coupon rate. The aims of the team are to evaluate the CFOproposal andhelpingthe CFOwith data calculation so she has enough information to make an informed decision for this project. In the following chapter, the summary of data and assumption will be presented. Also, the processing and calculation data prior to the calculation of capital structure will also be addressed in this part. II. Data Collection and Fact Findings According to the summary description above, below are the numbers of Stephenson Real Estate Capitalization: Stephenson Real Estate Recapitalization Data Outstanding Share 15,000,000 StockPrice 34.50 MktCap 517,500,000 Rwacc 12.5% Expected post-tax earning 64,687,500
  2. 2. With a number of outstanding shares of 15 million shares and a stock price of USD 34.50, the market capitalization of Stephenson is around USD 517.5 million. With the cost of capital is around 12.5% annual, the expected-post tax earnings of the company should be around USD 64.69 million. Move onto the projectdescription,accordingtoabove data,the summaryof the new project according to the data provided by Stephenson: New Project of Stephenson Real Estate Data Land cost 95,000,000 Incresead in Earning pre-tax 23,000,000 Incresead in Earning post-tax 13,800,000 PresentValueof theProject 110,400,000 Net PresentValueof The Project 15,400,000 Coupon Rateof Bond 8% Debt/Debt+Eq 0% Eq/Debt+Eq 100% Tax rate 40% Total Post-taxexpected earnings 78,487,500 Currentland cost values as USD 95 million and the Earning pre-tax will be increased by USD 23 million. The earningpost-tax will be atUSD 13.8 million.The total expectedearningswill be increased up to USD 78.49 million.Byapplyingthe calculationof NPV onthe project data, the present value of the project is USD 110.4 million. As a result the NPV of the project is around USD 15.4 million. III. Cost of Capital Calculation 1. Cost of Equity Under the Capital AssetPricingModel,the expectedreturnonthe stockcan be interpreted asfollow: Rs = Rf + β*(Rm-Rf) Where Rs isthe expectedreturn,Rf isthe risk-free rate, βisthe stockbeta and (Rm-Rf) isthe marketrisk premium. For the US market, the standard assumption is the market risk premium is around 7%. As
  3. 3. seen in the chapter two, the beta of dell is around 1.26 (36 months monthly return moving average period).Forthe riskfree rate,basedonthe table 3 above,the teamfeels that it is acceptable to choose a risk free rate of 3%. The 3% riskfree rate can reflects a longer period debt and prudently forecast the cost of equity for this case. Following are the result of the calculation: CAPM Model Risk Free Rate 3% Beta 1.26 Market Risk Premium 7.00% Expected Return (with Dell Beta) 11.82% Expected Return (with Industry Weighted Market Cap Beta) 9.80% Expected Return (with Industry Equally Weighted Beta) 10.44% Table 4. Dell cost of Equity Result It provesthatthe cost of equity or the expected return of Dell is ranging from 9.80% to 11.82% depend on the beta in question. If the calculating is being made for Dell, then Dell cost of equity is 11.82%. Alternatively,thisresultmustbe revertedtoGoff computing,as such two other CAPMoutputs with the betaof industry(weightedaverage andequallyaverage). The range of variation of the expected return is around 2% depend on the beta in used. With the weighted average beta, leading company in the industry such as Apple has a massive market cap. The beta of Apple is relatively and strangely slow whichleadstothe overall beta(weighted) of the industryisconsiderablyslowercomparingtoDell.With equallyweighted,the beta show sign of improvements up to 1.06, thus increased the cost of equity to 10.44%. It is also noteworthy to point out that the competitors of Dell and/or Goff such as Sony, Toshiba, Samsung,Lenovo,Acerare beinglistedacross Stock market in Asia, from Tokyo, Seoul to Taiwan, Hong Kong. The way of calculating beta might be different on these floors comparing to US standard. Furthermore, these countries currency might be appreciated strongly against the US Dollar which will create more fluctuation on their stock market as well. In the second section of this writing, team will attack the valuation of the cost of debt of Dell. 2. Cost of Debt As mentionedinthe chapterI,Goff computinghasno debtyet.Theyfinance theirproject usingtheir ownprofit.Inthiscase Dell sotof debtwill be calculatedasareference forGoff Computing.Basedon the table 2, here isthe cost of Debtstructure for Dell: Dell Cost of Debt Calculation
  4. 4. Bond Symbol Coupon Price Yield Book Value (inm USD) Book Value Yield(in m USD) % of Total Book Value Market Value (inm USD) Market Value Yield (inm USD) % of Total Market Value DELL.GJ 3.38% 101.14 0.71% 400 2.84 0.05% 404.54 2.9 0.04% DELL.GF 4.70% 105.00 0.76% 600 4.55 0.07% 630.00 4.8 0.07% DELL.GL 1.40% 100.91 0.85% 500 4.23 0.07% 504.57 4.3 0.06% DELL.GP 5.63% 100.23 0.00% 500 0.00 0.00% 501.16 - 0.00% DELL.GO 2.10% 101.91 1.23% 300 3.69 0.06% 305.72 3.8 0.05% DELL.GI 5.63% 109.96 1.15% 400 4.60 0.07% 439.82 5.1 0.07% DELL.GM 2.30% 102.45 1.61% 700 11.26 0.18% 717.15 11.5 0.17% DELL.GQ 3.10% 107.36 1.30% 400 5.21 0.08% 429.44 5.6 0.08% DELL.GG 5.65% 116.37 2.78% 500 13.92 0.22% 581.86 16.2 0.24% DELL.GK 5.88% 118.89 3.02% 600 18.10 0.29% 713.36 21.5 0.31% DELL.GR 4.63% 109.62 3.40% 400 13.60 0.22% 438.46 14.9 0.22% DELL.GB 7.10% 123.47 4.98% 300 14.93 0.24% 370.41 18.4 0.27% DELL.GH 6.50% 122.95 4.93% 400 19.72 0.31% 491.82 24.3 0.35% DELL.GN 5.40% 106.50 4.97% 300 14.91 0.24% 319.50 15.9 0.23% Total 2.26% 6300 131.55 2.09% 6847.80 149 2.18% The calculationabove showed that, the range of cost of debt varies from 2.09% to 2.26%. The yield can be calculatedfromsimple averagingtoweightagainstthe bookvalue of longterm debt or market value of the long term debt. The different between book value and market value is around 0.09%. It isalso noticeable thatDell hasmore than USD 1.8 billioninshort-termloan.It is possible to including it intothe calculationcostof debt. However, these short term loan have very low interest rate (0.33%) and usually take around 30-90 days to paid off. This interest rate will lower the overall cost of Debt of Dell and might lead to an unclear estimation cost of Debt. It also appears that the Dell bond increased almost 9% in value and the yield increased by 13%. As a result,itseemsthatcompanylike Dell isnow movingtowardsadebtfinancing structure due to the fact that the cost of debt is considerably low. 3. The Cost of Capital The cost of capital (Rwacc) can be estimated using the below formula: 𝑅𝑤𝑎𝑐𝑐 = 𝑆 𝑆 + 𝐵 ∗ 𝑅𝑠+ 𝐵 𝑆 + 𝐵 ∗ 𝑅𝑏 ∗ (1 − 𝑡𝑐) Where B/S is the debt-equity ratio, Rs is the Cost of Equity, Rb is the cost of Debt and tc is the corporation tax rate. Following are the result: Dell Rwacc calculation Total Long Term Debt 6847.8 Total Equity 28420 Total Company Value 35268
  5. 5. % of Debt 19.42% % of Equity 80.58% Corporation Tax Rate 35% Rwacc (Dell beta CAPM) 9.81% Rwacc (Industry Market Cap weighted beta CAPM) 8.18% Rwacc (Industry Equally weighted beta CAPM) 8.70% The team chose to use the marketvalue of the bond for presenting Dell long term debt and choose the highestyieldforcostof debt. Such approach can be considered prudent for the case of Dell. The result showed that the range of Dell Rwacc is running from 8.18% to 9.81%. When using the book value as long term debt, the rates increase almost one percent and ranges from 8.81% to 9.94%. As we all known that the smaller the size of the company is, the more expensive fundingcompanywill get.Dell cost of capital is from 9 to 10%. CGI is at a much smaller size compare to Dell,the costof capital forCGI is likelytobe addedfrom 1% to 3% interest premium compare to Dell. It seems that the minimum cost of capital of CGI will be likely around 12% to 12.5%. III. Conclusion In conclusion, due to the lack of track record from CGI, Dell is being employed to estimate the cost of capital for CGI. However, there are several drawbacks to this approach. First of all, Dell and CGI do not have the same operating model. While Dell is custom-made online and has no store, CGI sells its good in-store. Dell does not spend their money in open store. Secondly, the site of Dell and CGI is considerablydifferent.Dell isglobal corporationwhile CGI is a regional privately owned company. The cost of capital of CGI will be quite higher than Dell. In addition, the premium which CGI has to pay cannot be forecasted with ease. It is better to find another company which operating in the same businessmodellike CGIforcalculatingthe costof capital. Finally,there iscompanylike CompUSA which has an operation model like CGI but unfortunately being bought by TigerDirect (another company operate like Dell). For the Goff computing,there are a fewideasthroughthisanalysiswhichworthto consider. The cost of financing through equity is almost 5 times higher than financing through debt. Since the company is privately owned by the family, financing through long-term debt is worth to try. Second lesson is that through the competitor lists, most of the top company is selling heavily online and focus on e- commerce. Perhaps Goff computing might like to change its operation model to adapt and survive. Math homework help https://www.homeworkping.com/