Telus: The Cost of Capital
Telus needs to calculate the cost of capital from the variety of data given. The cost of capital is determined mostly by how the funds are used rather than where they were obtained from. It relies on the risk of investments Telus involves in, therefore, depending on cost of both equity of debt as described below. Also note that, even though the preferred shares are not attractive to issuers and may not get issued again, it is still on the company’s balance sheet and affect firm’s overall wealth.
PREFFERED SHARES
We assume that Telus maintains a fixed debt to equity ratio and hence, the calculation will include preferred shares. 5.00 percent of cost in the past cannot be used towards final calculation
…show more content…
Therefore, the cost of common stock is obtained by using the dividends divided by the market price.
Another problematic issue is that the accounting rate of return can not be used to compute the cost of equity because normally accounting rate of return is in book value rather than market value. The value of the stock will fluctuate greatly from year to year while the book value does not indicate any risk or future cash flows at all, so it is crucial to calculate the cost of equity by using market value.
Given: price/share: $25; # of shares outstanding: 287,000,000 (in footnotes)
Therefore, market value = 287,000,000 x $25 = $7,175,000,000
Re: 10.04% (as shown below in details)
Dividend Growth Model:
We obtain the growth rate g in the dividend growth model by calculating the geometric average for the last 10 years based on Common DIV/SH.
The approx. growth rate g is 0.30 (1+g)31 = 1.40 g ≈ 0.0509 ≈ 5.09%
Re=D1/Po+g=Do(1+g)/Po + g=(1.4(1+0.0509)/25)+0.0509 = 0.10975
Re ≈ 11.00%
CAPM Model
According to the newspaper, the Rf (risk free-rate) for a long-term Government of Canada Bonds is 5.82%. The RM (return on the market) as the geometric average for Market Index is 10.2%. For the accuracy reason, we chose to use the geometric average for both long-term government bonds and market portfolio.
Re =Rf + β (RM - Rf) = 0.0582 + 0.75 (0.102 – 0.0582) = 0.09105or
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
-Martin Industries just paid an annual dividend of $1.30 a share. The market price of the stock is $36.80 and the growth rate is 6.0 percent. What is the firm's cost of equity?
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
Two managers attending an executive education course attempt to develop a cost of capital estimate for a leading telecommunications company, Telus The two managers are somewhat confused about the costs of various sources of capital, the calculation of the overall cost of capital and the appropriate use of the hurdle rate
* She is considering the cash flow paid to all the equity or debt holders. So she cannot use the equity cost of capital.
The three components of the cost of capital are debt, preferred stock, and common stock.
Please refer to Appendix 2 for other considerations for cost of equity calculations. Most firms use the Capital Asset Pricing Model (CAPM) to determine the cost of equity. The components that make up the CAPM include: the risk free rate, the beta of the security, and the expected market return of the stock. These values are all based on forward-looking data. The model dictates that shareholders require a return equal to the return from a risk-free investment plus an equity risk premium for bearing extra risk. Refer to Appendix 1 for a full breakdown of the CAPM formula.
Cost of Equity is the return that stockholders require for a company. A company’s cost of equity represents the compensation that the market demands in exchange for owning the assets and bearing the risk of ownership. Based on capital markets the cost of equity varies in direct relation to the assumed risk in that specific market. The distinctive of the firm is the sensitivity to market risk (β) which depends on everything from management to its business and capital structure. Therefore past performances and present conditions have a direct effect on the overall value. Applying calculations at a divisional level allows specified markets to be analysis based on present market conditions for that service or product. The formula used to calculate Cost of Equity is:
3. If Lex had no debt in its capital structure, what would be its cost of capital? How could this estimate be used to value Lex? If Lex operated with essentially no leverage in its capital structure and then added a moderate amount of debt, how would this affect its total value? How might we capture this value impact of debt in our valuation analysis?
The Teletech Corporation is currently using a single, constant, hurdle rate for their two different segments, which are, telecommunications services and products and systems divisions. Based on the estimate of corporation’s WACC, the hurdle rate is the cost of capital.
In this scenario Margret Weston, received a letter. In the letter she found out that Yossarian acquired 10% of the company’s stock. This aggressive move by Yossarian was motivated by the company management not doing their job to maximize shareholders wealth. Moreover, the managers were having issues with the hurdle rate, because it is just generally accepted, but not scientifically proven. On the other hand one TV Commentators opinion about Teletech Corp. is that “there is no way to have a hostile takeover in this sector, but for the Teletech Corp. there are many reasons to try.” Teletech Corp. has two major business segments, Telecommunication Services and both Product and System Manufacturing make up the other segment we will analyze.
The market risk premium of 5.5% and the risk free rate of 4.62% (30-year U.S. Treasury) were given in the case. The beta and the pre-tax cost of debt are based on our averaged comparative company analysis. Using the averaged beta of 1.05, the pretax cost of debt of 5.79%, (based on bond ratings) and the weighted average of debt & equity, the telecommunications segmented hurdle rate is calculated at 8.64% (see Exhibit 2).
3. Calculate the cost of equity capital using the CAPM, assuming a market risk premium of 5%.
No Growth 8.33 P0 $55.56 .15 With Growth g .25 .40 .10 5.00 P0 $100.00 .15 .10
[(Pt – Pt-1) / (Pt-1)] = capital gain over time t – 1 to t