Weighted Average Cost of Capital Analysis

This assignment delves into the concept of the Weighted Average Cost of Capital (WACC). It examines how WACC is calculated, its significance in determining a company's cost of financing, and the potential consequences for firms facing financial challenges. The analysis includes the role of investor sentiment, market speculation, and the possibility of corporate takeovers driven by a firm's declining WACC.

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AVEO COMPANY
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Weighted average cost of capital (WACC) depicts a company’s financial position in
(miles & Ezzell, 2012)consideration to its ability to finance innovative projects or other
payments by raising cash from external sources. These sources appear in two main classes:
stocks and bonds. The two have distinct costs to the firm, and WACC is a subjective average of
the entire price of getting funds via debit and equity.
Suggestion of Aveo group WACC
Recent research shows a considerable decrease in cumulative percentage of Aveo group
Weighted Average Cost of Capital. According to 2016 statistics the group WACC was recorded
to have declined to a percentage of 3.4.The decline brought about several suggestions to the
financial analysts. Briefly, the suggestions attempt to explain the reasons which might have led
to this considerable decline (Pricing & Tribunal, 2013).
The company might have lowered the price of issuing equity
Price of equity basically is used by financial analysts to refer to the stockholders required
return rate on the company equity investment. It similarly depicts the return rate that would have
been realized by investing the cash in a different venture with an equivalent risk level.
Price of equity is a crucial factor of stock analysis. An investor will always expect an
equity share to propagate by at least the price of equity; price of equity is commonly used as
concession rate to compute an equity venture’s fair price. Considering the Aveo group scenario,
lowering the terms of issuing equity will attract investors and this might have been the reason
behind the decline in the average WACC (Arditti & Levy, 2014).
The company might have reduced the price of debt

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Price of debt basically denotes the rate at which a company recompenses its current debt.
In most cases, it is used to refer to the after-tax price of debt; it can also denote to a firm’s price
of debt before putting taxes into consideration. This measure is essential for giving a notch on
the overall rate in the process of payment by a company using debt financing. The measure gives
investors an insight on the company risk in comparison to the others; riskier companies usually
have a greater cost of debt. Lowering the price of debt by the Aveo group might have attracted
potential investors and hence reducing the WACC (Arditti, 2015) .
The WACC is settled through intricate calculations and conventions about the different
types of capital (debt and equity) used by Aveo group to fund its operations. Costs are restrained
against approximate risk elements. Greater subsidy costs and greater risks create a greater
WACC. A lesser WACC increases incomes because the company can borrow cheaply (Brusov,
et al., 2011).
Calculating the WACC
The formula is:
WACC
=E/
(E +
D)
*Cost of Equity+D/(E + D)*
Cost of
Debt
*(1 - Tax Rate)
Weights
Company’s possessions are funded by both debts and equity. For that reason, in
calculating the company’s WACC the burden of equity and the burden of debt must be
considered first. The equity market value of Aveo group also known as the Market Cap has been
recorded as $M 1,388.The value of debt in the market typically being hard to compute, this paper

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uses the book figures of debt to carry out the calculations. According to the book value $0
(Bourdex & Long, 2013).
a)Weight of equity = E / (E + D) = 1,388 / (1,388 + 0) = 1
b) weight of debit = D / (E + D) = 0 / (1,388} + 0) = 0
Price of Equity:
This paper makes use of CAPM (Capital Asset Pricing Model) model to compute the
required return rate. The formula used is: price of Equity = Risk-Free Rate of Return + Beta of
Asset * (Expected Return of the Market - Risk-Free Rate of Return) (Linke & Kim, 2013)
a) The paper evaluates a 10-Year Reserves Perpetual Maturity Rate as the risk-free rate. The
current risk-free rate of Aveo group is 2.41000000%
b) Beta refers to the volatility of the anticipated surplus asset paybacks to the anticipated surplus
market paybacks. Aveo group beta is 3.15
c). This paper considers the market premium of Aveo group to be 20%.
Price of Equity = 2.41000000%+ 3.15 * 20% = 63.241%
The Price of Debt:
The research uses last fiscal year end expenses on interest and divide them by the two
year average debt to attain a simplified cost of debt; Cost of Debt = 0 / 0 = %.
Multiply by one minus Average Tax Rate:
The paper makes use of the current 2-year tax rate for computation.
The current 2-year Average Rate of Tax is 0%

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The Aveo group WACC can hence be computed as:
WAC
C
=
E / (E +
D)
*Cost of Equity+D / (E + D)*Cost of Debt*(1 - Tax Rate)
=1 *63.241% +0 *% *(1 - 0%)
=63.241%
Lowering the WACC
Considering all the different components forming the weighted average cost of capital is
the initial step to making efforts to lower it. With consideration to debt, firms can lower their
cost of giving bonds by reducing the rates of interest they offer to the investors. They become
more creditworthy as a result: Firms with bad credit ratings are forced to offer greater rates on
bonds. The firm can also move to a location with a greater tax rate, but this is perhaps
counterproductive (Ross, et al., 2013).
In regards to equity, a firm that offers stocks with small beta is a reduced amount of risky
to the investors and consequently can offer small of a risk premium. The other components, the
threat-free premium and the overall market risk, are outside of the firm’s control (Reilly &
Wecker, 2014).
Aveo group capital arrangement
The capital structure refers to how a company funds its general activities and
development making use of different sources of reserves. Debt emerges in bond form issued or

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extended-term cash payable, whereas equity is classified as common/ preferred stock or reserved
earnings (Nantell & Carlson, 2015).
Analysis of Aveo group Capital structure
Aveo group capital structure as per the recent research has indicated an ill proportion of
equity to asset proportion. This simply shows that the company relies largely on debt capital as
compared to its equity. Since a healthy proportion of equity capital indicates that a company is
financially fit, this trend of Aveo group to rely mainly on debt is a clear indication that the
company is financially unfit (Titman & Wessels, 2013).
Appropriate capital structure recommendation for Aveo group
The word capital structure is used to exemplify the proportionate connection between the
numerous long-term categories of capital schedules the equity, debentures, inclination shares,
long- term liability, capital excess, and reserved earnings. For a capital structure to be termed as
appropriate, it must meet some important features (Brusov, et al., 2011),

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Flexibility
The impression of adaptability gives the back administrator the ability to adjust the
company's capital structure with a base cost and deferral, if justified by the changed condition. It
ought to likewise be workable for the organization to give reserves at whatever point expected to
back its productive exercises (Bourdex & Long, 2013).
Profitability
A sound capital structure should allow the greatest utilization of use at least cost in order
to give better productivity and consequently expanding profit per share (Nantell & Carlson,
2015).
Solvency
Broad obligation debilitates the dissolvability and FICO score of the organization. The
obligation financing ought to be just to the degree that it can be overhauled completely and
furthermore be paid back (if required) (Brusov, et al., 2011).
Conservatism
No organization ought to surpass its obligation limit. As of now clarified that the intrigue
is to be paid on obligation and the foremost aggregate is likewise to be paid. These installments
rely upon future money streams. In the event that future money streams are not adequate then the
money indebtedness can prompt lawful bankruptcy (Evans & Kelvin, 2014).
Control
The capital arrangement ought not to prompt loss of regulation in an organization.

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The Proposed capital structure for Aveo group
The Optimal capital structure
An optimum capital arrangement is the best debt-to-equity ratio for Aveo Group in order
to maximize its value. The optimum capital arrangement adoption by the Aveo group will offer a
balance between the company’s ideal debts to equity level and minimize its price of capital.
Theoretically, debt funding offers the lowest price of capital because of the tax deductibility
(Brusov, et al., 2011).
Risky associated with optimum capital structure
In monetary terms, debt is a moral instance of the reputed 2-edged sword. Intelligent
utilization of debt upsurges the aggregate of monetary assets available to a firm for its advance
and enlargement. The postulation is that management can get additional on loan reserves than it
recompenses in interest expenditures and charges on these reserves. Though, as effective as this
formula may appear, it requires a firm to uphold a solid record of conforming to its numerous
borrowing obligations (Bourdex & Long, 2013).
A company reflected to have high debts may find its liberty of actions limited by its
creditors and its productivity offended as a consequence of repaying high interest costs. Of
course, the situation is considered to be worst-case if the company faces distress meeting
functioning and debt obligations in times of hostile economic circumstances. Lastly, Aveo group
being a highly competitive firm, shuffled by huge debt, will find its opponents taking advantage
of its hitches to seize large market shares (Harris & Raviv, 2015).

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Dividend policy
Because dividends signify a form of revenue for investors, a company's dividend policy
is an essential contemplation for some investors. Intrinsically, it is crucial consideration for
company management, particularly because firm leaders are often the prime shareholders and
have the most to advance from a substantial dividend policy. Most firms consider a dividend
policy as a fundamental part of the company strategy. Board must resolve on the dividend extent,
timing and some other factors that impact dividend overheads over time. There are three
categories of dividend policies: stable, constant and residual dividend policy (Titman & Wessels,
2013).
The current analysis based on the Aveo group Analysis of Aveo group has shown an ill
trend based on the dividend practices, this is depicted by its percentage stand of 3.91%. this is a
low stand basically (Brusov, et al., 2011).
Dividend pattern and policy followed by the Aveo group
Stable Dividend Policy
This is the easiest and most frequently used policy by many organizations. The policy
goal is to achieve steady and foreseeable dividend disbursements every year, which is what many
investors really like (Teshtesh & Titus, 2013). When remunerations are up, shareholders get a
dividend. Still when remunerations are down, investors as well receive a dividend. The goal is to

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support the dividend policy with the long-term advance of the firm rather than with periodical
earnings instability. This approach permits the investor to have more confidence around the
amount and scheduling of the dividend.
Analysis on Aveo group share price and company performance
Aveo Group's share price according to recent research shows it’s below the impending
cash flow worth, and at a substantial discount of below 20 percent. Dividends per stake has gone
down over the previous 10 years (Evans & Kelvin, 2014).
General decline in Share prices
There have been falls in the general share prices in the Aveo group. The stock market is
pretty impulsive, upsurge and decline in the share prices won’t shake its general business
directly. Conversely, if there is a constant decline in share prices (Brusov, et al., 2011), it may
discourage the firm from supplying more shares to increase revenue. For example, in the climate
of stock market instability, firms wouldn’t have much assurance in supplying more shares as
they would get a low profit. A large decline in share prices may cause broader economic hitches.
Underperforming Shares
A firm may see a sharp fall in share value with respect to different firms (rest of money
markets). This will happen if speculators are not hopeful about prospect of firm to make benefit
and pay great profit. e.g. in the event that firm makes an extensive misfortune it won't have the
capacity to pay a profit to investors and this makes the offer less appealing (Bourdex & Long,
2013).

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This decline in the offer cost could make the company powerless beside an assume
control. This would apt an alteration in proprietorship. The new management may decide to
adjust the approach for dealing with the organization. They could sale unfruitful parts of the
corporate and significantly change things (Arditti, 2015).
Work cited
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use. journal of finance, Volume 654, pp. 34-45.
Arditti & Levy, 2014. The weighted average cost of capital as a cutoff rate, a critical analysis of weighted
average. journal of financial management, Volume 567, pp. 234-254.
Bourdex & Long, 2013. weighted average cost of capital as a cutoff rate; a further analysis. s.l.:s.n.
Brusov, Filatova, Orehova & Brusova, 2011. weighted average cost of capital in the theory of modigliani-
miller, modified for finite lifetime company. journal of applied economics, Volume 234, p. 56.
Evans & Kelvin, 2014. corporate perfomance analysis. journal of recent finance states, Volume 8765, p.
564.
Harris & Raviv, 2015. The theory of capital structure. journal of finance, Volume 254, p. 34.

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Linke & Kim, 2013. More on weighted average cost of capital: a comment and analysis. journal of
financial and quantitative analysis, Volume 987, p. 345.
miles & Ezzell, 2012. the weighted average cost of capital, perfect capital markets and project life.
journal of financial and quantitative analysis, Volume 2345, pp. 123-145.
Nantell & Carlson, 2015. The cost of capital as weighted average. journal of finance, Volume 567, p. 76.
Pricing & Tribunal, 2013. Weighted average cost of capital. journal of economics, Volume 765, pp. 123-
345.
Reilly & Wecker, 2014. On the weighted average cost of capital. journal of financial and quantitative
analysis, Volume 876, p. 234.
Ross, Westerfield & Jaffe, 2013. Corporate finance. s.l.:s.n.
Teshtesh & Titus, 2013. the basics of dividend policy. journal of corporate finance, Volume 453, p. 34.
Titman & Wessels, 2013. choices of capital structure in the economy analysis. journal of finance, Volume
453, p. 45.
Titman & Wessels, 2013. determinants of capital structure choice. journal of finance, Volume 1097, p.
543.

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