International Cost of capital Assignment Example | Topics and Well Written Essays - 1750 words

International Cost of capital - Assignment Example Question1. Provide an illustrative example of WACC calculation using a FTSE100 company. Answer: The components of weighted average of cost of capital come from the equity side of the statement of financial position, which is commonly understood and known as balance sheet-common shares, preferred shares and debt, long term liability are the components of capital. Any change in the shape of increase in assets of the balance sheet would require increasing at least any one of components of the capital account. In order to increase the liability side of the balance sheet, the cost of these components is called as component based cost of capital. Numerous causes require to occur or to increase the cost of capital. First, the need of long term investment and long term financing requires a company to determine and decide an appropriate way of arranging finance. Either willingly or unwillingly, the company has to evaluate all possible and available means that can be used for the purpose of sa tisfying their long term business investment needs. Some companies use and issue preferred shares for the purpose of raising finance. ... On the whole, these both means have some sort of similarities and some sort of dissimilarities. Preferred shares are mostly placed with the ordinary shares, on the other hand, the debentures and other forms of long term liabilities are incorporated in the long term liability section of the statement of financial position. Following is the standard computational method of weighted average of cost of capital: WACC = Ke [(market value of equity/A)] + kd [(1-t) (market value of debt/A)]. Where; WACC= weighted average of cost of capital Ke= cost of equity A=market value of equity + market value of debt Kd= cost of debt Cost of equity (Ke) is the required return on the ordinary shares. Most of the time, it is this feature that is pretty difficult to estimate. Cost of equity can be determined by two ways: dividend growth model and capital asset pricing model (CAPM). The dividend growth model uses the following formula: P0 = D1/ (Re-g) Here, P0 is the current stock price or stock price in th e period of 0. D1 is the amount of dividend in the next period or next year. Re is the cost of equity. G is the dividend growth rate. For ke the equation would become Re= D1/ P0+ g The capital asset pricing model (CAPM) helps with the following equation to determine the cost of equity: Re= Rf+ b(Rm - Rf) Here, Rf= the risk free rate. B= beta value Rm= market return Capital asset pricing model was determined and defined and published its derivation by William Sharpe in the year of 1986 (Megginson, 1996). There are numerous assumptions on which capital asset pricing model is based on. For instance, capital asset pricing model assumes that investors hold diversified range of portfolios (Head, 2008). Example: Computation of weighted average of