Finance for International Business: Capital Cost Presentation 7BSP1245

This presentation, prepared for the 7BSP1245 Finance for International Business module, focuses on the crucial topic of capital cost estimation. It delves into the concepts of cost of capital, differentiating between the cost of debt and the cost of equity, with detailed formulas and explanations. The presentation further explores the Weighted Average Cost of Capital (WACC), its calculation, and its significance in financial modeling. It highlights the challenges encountered when estimating WACC, particularly in complex capital structures like that of Bellingham Plc, and discusses the forward-looking nature of WACC calculations. The presentation includes references to relevant sources, providing a solid foundation for understanding capital cost analysis in a practical business context.

Estimating
Capital
Costs

Cost of Capital
 It is the cost of the firm’s funds weather it is debt and
equity.
 This cost of capital also states the opportunity cost of
making a specific investment.
 It also helps to estimate the rate of return which is
earned by investing the same amount of money on
different investment areas (Pant, 2019).

Estimation of Capital Cost
 The cost of capital has been evaluated with the
formula of:
Cost of Capital= Cost of Debt + Cost of
Equity
Cost of Debt= Interest Expenses x (1- Tax Rate)
Cost of Equity= Risk-Free Rate of Return +
Beta * (Market Rate of Return - Risk-Free Rate
of Return)
(Wallstreet Mojo, 2019).

WACC
 WACC stands for Weighted Average Cost
of Capital
 It represents its blended cost of capital
all resources
 WACC is used in financial modeling as
the discount rate to determine the net
present value (CFI, 2019).

Estimation of WACC
 The formula of WACC (Weighted Average Cost of Capital) is :
WACC = (E/V x Re) + ((D/V x Rd) x (1 – T))
E = market value of the firm’s equity (market cap)
D = market value of the firm’s debt
V = total value of capital (equity plus debt)
E/V = percentage of capital that is equity
D/V = percentage of capital that is debt
Re = cost of equity (required rate of return)
Rd = cost of debt (yield to maturity on existing
debt)
T = tax rate

WACC Bellingham plc (2019): Operating Forecast for American
Creations
All values $*1000
INPUT DATA
Initial Values:
Sales Revenue 9606
Commissions
Variable Costs:
Labour 3,818
Materials 216
Fixed Cost: Manufacturing
General O/H
Depreciation: Factory
Office
Interest 53
Growth Rates:
Sales 9606.00
Comissions
Lab Costs 3818.00
Materials 216.00
Fixed Cost: Manufacturing
General O/H
Other Data:
Corp Tax, USA
Exchange Rate $/£
Am Creations: value @ ask price $(k) 581
Am Creations: value @ ask price £(k) 449
WACC

Problem encountered in estimation
 WACC is a forward looking calculation which is
based on expected return not on historical
return. This is a major factor that has to be
considered while evaluating the cost of capital.
 It is very difficult to evaluate the Bellingham
Plc.as its capital structure is highly
complicated.
 It is also a challenge to collect the information
regarding the rate of risk (E-finance
management, 2019).

Problem encountered in
estimation
 It is also difficult for the company to acquire
current market cost of capital.
 Sometimes, the important sources of capital has
been avoided due to complexity of capital
structure.

References
 CFI. (2019). Definition of WACC. Available From: https
://corporatefinanceinstitute.com/resources/knowledge/finance/wh
at-is-wacc-formula
/ [Accessed 22/3/2020].
 E-finance management. (2019). Evaluating New Projects with
Weighted Average Cost of Capital (WACC). Available From: https
://
efinancemanagement.com/investment-decisions/evaluating-new-
projects-with-weighted-average-cost-of-capital-wacc
[Accessed 22/3/2020].
 Wallstreet Mojo. (2019). Cost of Equity Formula. Available From:
https://www.wallstreetmojo.com/cost-of-equity-formula/
[Accessed 22/3/2020].
 Pant, S. (2019). Cost of Capital: Meaning, Importance and
Measurement. Available From: http://
www.yourarticlelibrary.com/financial-management/cost-of-capital
/cost-of-capital-meaning-importance-and-measurement/65195
[Accessed 22/3/2020].