Summary Modigliani & Miller

Barb Williams and Rick Thomas, while attending an executive education course at a well-known business school, came across a case which involved calculating the cost of capital for Telus Corporation (Telus). Basic data such as the Balance Sheet, Income Statement, Data on Telus’ Common Stock, Market Index, and the Average Annual Returns in North American Capital Markets were provided. In order to calculate Telus’ cost of capital we need to calculate the company’s Cost of Equity, Cost of Debt, and Tax Rate along with their weighted cost and then apply these to the Weighted

The Return on Equity ratio is a measure of the efficiency with which a company employs owners’ capital. It

The cost of equity is the theoretical return that equity investors expect or receive from the company for investing their funds in the company. The risk free rate that is the Government Treasury bill rate is 3.1%, the market risk premium is 7% and the beta has been calculated as

In November 2001, the costs of required rates of return on debt in the capital market are as follows:

The cost of debt (kd) rate of 13% was used after we assessed the key industrial financial ratios and compared them with that of Wrigley’s (See Appendix 2) to conclude that it was in the range between the BB rate of

Cost of Debt = (1-Ʈ) rd, where rd is the rate for pretax cost of debt and (1-Ʈ) represent the tax shield.

Capital budgeting is the most important management tool that enables managers of the organization to select the investment option that yields comprehensive cash flows and rate of return. For managers availability of capital whether in form of debt or equity is very limited and thus it become imperative for them to invest their limited and most important resource in perfect option that could prove to beneficial for the organization in the long run (Hickman et al, 2013). However, while using capital budgeting tool managers must understand its quantitative and qualitative considerations that are discussed below.

1. For what purposes does Mortensen estimate Midland's cost of capital? What would be the potential consequences of a too high estimate compared to the firm's “true” cost of capital? What about a too low estimate?

a. Capital budgeting is the process of analyzing projects and determining which ones to accept and include in the capital budget.

The cost of using borrowed funds should be less than the return generated by the borrowed funds.

Equity Ratio measures percentage of assets provided by shareholders and the extent of using gearing.

This case study focuses on where financial theory ends and practical application of the weighted average cost of capital (WACC) begins. It presents evidence on how some of the most financially complex companies and financial advisors estimated capital costs and focuses on the gaps found between theory and application. The approach taken in the paper differed from their predecessors in several various respects. Prior published information was solely based on written, closed-end surveys sent to a large number of firms, without a focused topic. The study set out to see if financial theory, specifically cost-of-capital, is truly ubiquitous in true business applications.

* We assume the cost of capital to be a stated annual rate to facilitate calculations;

This section starts with the theory of irrelevancy of capital structure. Following subsections give the overview of theories that suggest that the capital

Already in 1958, Modigliani and Miller have pointed the discussion of capital structure towards the cost of debt and equity. According to their first proposition, in a world of no corporate taxes and with perfect markets, financial leverage has no effect on a firm’s value. In their second proposition, they state that the cost of equity equals a linear function defined by the required return on assets and the cost of debt (Modigliani and Miller, 1958).