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The aim of this assessment task is to apply finance theory and concepts to the practical estimation of a firms cost of capital and provide a report to management.
You will be required to search for data or calculate variables as part of the assignment to find financial information such as the firm’s cost of debt, beta and current risk-free rate (try to match the risk-free rate with the project duration; for a 10-year investment, the Commonwealth Government 10-year Treasury Bond yield is appropriate).
Through the JCU Library website you can access the Morningstar database (DatAnalysis). Searching other websites such as the Reserve Bank of Australia is also required. The reserve Bank of Australia has information on the Commonwealth Government Bond rates and also information on indicated lending rates for public companies (the indicated lending rates tell us the rates that major banks are using for large and small company loans).
Occasionally, the cost of interest that we calculate tends to be accurate and is unlikely to be the rate the company is using. This arises because companies can capitalise interest in certain circumstances; that is, they can take some of the interest that would normally be an expense and add it to the cost of an asset. Where this occurs, we use indicated lending rates. In all cases you must note where you obtained information from and the date of access as part of your referencing.
Tasks:
- Calculate the weighted average cost of capital using an appropriate technique.
- Explain your calculations and the judgements you made in arriving at your answer.
- Calculate the gearing ratios and describe any difficulties in doing so.
- Analyse your findings with reference to capital structure theory.
- Provide a recommendation to the Board on the target firm’s current capital structure.
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