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Nguyen The Cam Hoan
Le Tung Bach
HB Group-Cohort 4 VEMBA HCM
Bus 633Case Study Finance Management
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
Stephenson Real Estate Recapitalization Data
Outstanding Share 15,000,000
Expected post-tax earning 64,687,500
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%
Tax rate 40%
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
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:
Risk Free Rate 3%
Market Risk Premium 7.00%
Expected Return (with Dell Beta) 11.82%
Expected Return (with Industry Weighted Market
Expected Return (with Industry Equally Weighted
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
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
Bond Symbol Coupon Price Yield Book
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:
𝑆 + 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
% of Debt 19.42%
% of Equity 80.58%
Corporation Tax Rate 35%
Rwacc (Dell beta CAPM) 9.81%
Rwacc (Industry Market Cap weighted
Rwacc (Industry Equally weighted beta
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%.
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.
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