Calculation of WACC, Gearing Ratio, and Capital Structure Theory: A Corporate Finance Analysis

The project report focuses on corporate finance, specifically calculating the weighted average cost of capital (WACC) and analyzing the company's performance through the gearing ratio. The calculation of WACC involves determining the cost of equity and debt, while the gearing ratio compares total debt to total shareholder equity. The report also explores capital structure theory and provides recommendations for investment decisions based on the analysis. Overall, the report emphasizes the importance of evaluating financial metrics for informed decision-making.

Corporate Finance

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
1: Calculation of WACC........................................................................................................1
2: Justification of the calculation............................................................................................3
3: Calculation of gearing ratio and its justification................................................................3
4: Capital structure theory......................................................................................................4
5: Recommendation................................................................................................................5
CONCLUSION................................................................................................................................5
REFERENCES................................................................................................................................6

INTRODUCTION
Corporate finance is basically said to be division of a company that is associated with the
financial as well as investment related decisions. It is primarily associated with maximizing
shareholder values by long as well as short-term financial planning. This project aimed at
providing specific information about the calculation of WACC about it analysis (Brealey and et.
al., 2012). Apart from this, evaluation of the company performance with the help of gearing ratio
is also covered under this report. Along with that evaluation of the finding through capital
structure theory has been find clearly in the below mentioned project report.
TASK 1
1: Calculation of WACC
It is said to be a company’s weighted average cost of capital (WACC) is the normal
interest rate that need to pay for the purpose of assets, growth and working capital. It is also
considered as minimum average rate of return that provides return on their current assets to fulfil
specific requirement of their shareholders such as investors or creditors (Belloc, 2012). It is
basically relying on the Aristocrat leisure limited capital structure and it is the combination of
both debt and equity. Cost of capital is more common concerning about the value of a firm pays
in order to finance their operations without being specific regarding the combination of their
capital structure (Hillier and et. al., 2013). Debt as well as equity tends to make up the capital
structure of Aristocrat leisure ltd, along with other capital on the right hand side of company
balance sheet like as preferred stock. Just as company get started to grow, they may use to get
valuable amount of financing from debt sources as well as irregular preferred reserve sources.
From the above formula,
Re: Cost of equity
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Rd: Cost of debt:
E= Market value of the firm’s equity
D= Market value of the firm debt
V=E+D: Combination of both debt and equity
OVERALL
Beta: 1
Market Cap $16,697.93
Shares
Outstanding
638.54
Dividend: 0.19
Yield (%): 1.49
Rm (Assumed) 8%
FINANCIALS
ALL.AX Industry Sector
P/E 33.29 18.36 17.65
EPS 0.79 -- --
ROI 13.94 10.83 12.65
ROE 36.41 30.49 14.51
Equity: 5847
Debt: 3097
Re : Rf +Beta (Rm - Rf)
: 10+(10-8)1
: 12%
Interest Expenses: 115.3
Total Long term debt:2881.1
Rd: 115.3/2881.1*100 = 4.00%
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Total Equity: 1732.5
WACC: (1732.5/4613.6)*12% +(2881.1/4613.6)*4% = 7% Approx
2: Justification of the calculation
From the above calculation, it has been seen that estimated stock market is based on the
current rate of return. It usually looks at the stock market index. The beta risk of the market is
taken as 1.0. If the risk is greater than the market, their beta is greater than 1.0. The values are
adjusted as per the historical beta for fundamental factors that are specific to the Aristocrat
company performance. After the calculation of the Cost of capital for all the specific sources of
debt and equity, it is the time to weight capital structure through using overall percentage for
every source. The cost of debt capital is taken as 1.8 percent as well as the cost of equity is
around 10 percent. If each would have made up with 30 percent of company capital structure the
results are all around that 7% (Flannery and Hankins, 2013). In case the company uses both
equity as well as debt financing in the manner as calculated above, the WACC would be
effective for them in coming decision making. The company yield is also around 1.4 % of the
total capital with the total number of outstanding share is around 638. The overall value of the
firms is valuable in terms of making other sorts of decision making in their respective projects.
There is certain limitation for investors because cost of equity is not consistent values, different
parties would report them separately for their respective reasons. WACC should often assist lend
valuable insight as per the company’s norms, one would always use this along with their other
metrics at the time of evaluating their investment decision in the company shares (Aggarwal,
Meschke and Wang, 2012).
3: Calculation of gearing ratio and its justification
Gearing ratio is one of the type of financial ratio that tend to compares company debt in
relation to various financial metrics such as total equity. It usually shows the financial leverage
of the degree to which Aristocrat limits their operation that are funded through equity capital in
accordance with the creditor financing. It is more general term that shown a financial ratio which
is compares few of the owner’s equity in relation with the borrowed capital. A gearing ratio
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tends to measure the entity of financial leverage that shows overall owner risk which is
associated with the company performance. It can be calculated through using below mention
formula:
Gearing ratio: Total liability / Total shareholder equity
: 4114 /1733: 2.37%
From the above calculation of the gearing ratio, it has been determining that an investor
can measures the proportion of a company’s total borrowed capital to their equity. The ratio
shows the financial risk to which a business is associated with that particular time period. Hence,
large proportion of debt can lead to maximum financial difficulties. It has been basically seen
that a gearing ratio which is calculated fewer than 25% is normally considered as less risky by
most of the investors as well as the financial analyst (Cumming, 2012). A company which is
having maximum gearing ratio is more vulnerable to downturn in their future business planning
because the company must tend to continue to services their debt in relation their total equity. As
per the above calculation, the ratio is around 3% which means that the performance of the
Aristocrat is more sustainable for investors. Thus, they can easily be able to make their
investment decision.
4: Capital structure theory
In accordance with the corporate finance, capital structure theory tends to be considered as
a well organise systematic approach to financing business activities by the help of both equity
and debts. Under the Modigliani and miller method, there are various capital structure theories
that are trying to establish a well effective relationship among the financial leverage of any firm
in respect to the market value (Vernimmen and et. al., 2014). This was find that valuation of the
firms is irrelevant to the given capital structure of Aristocrat limited company. With the high rate
of leverage or low debt element, it has no any sorts of bearing on market value. It is basically
relying on the operating gains of the company. Similarly, capital structure of Aristocrat is the
manner in which they tend to finance their assets. It can make decision for financing their
operation through either choosing debt or equity (Serfling, 2014). The capital structure of
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Aristocrat is having a majority of debt element or equity. Each sets of them is having their own
set of benefits and limitation. There is certain assumption of MM approach such as the cost of
borrowing would be same for all kind of investors as well as the other companies. There is no
any time of floatation cost such as underwriting commission, payment to merchant bankers and
so on. There is also no transaction or corporate tax involve. It means that investors would have
all kind of access to their similar information that a corporation is having in relation to the
decision making while planning for any investment (Edmans, 2014). MM approach shows that
the value of any leveraged firm is always remain same as the value of an unleveraged firm.
5: Recommendation
After analysing all the internal position of the company, it has been seen that no option over
company’s shares were taken granted to the executive during the financial year. Capital expenses
have also increase to 26% to $ 269 million. In case of recognition and measurement the
borrowing is firstly recognised at fair value. It would be measured at amortised cost with the help
of effective interest method. Financial assets are also analysed at fair value so that chances of
growth and generating maximum earning in near future would be more in near future time. As
well as it would be suggested to used share based payment reserves that is taken into account to
recognise the fair value of all the shares as well as rights (Derrien, Kecskés and Thesmar, 2013).
The investors need to make their valuable capital investment decision after taking the overall
cost of equity and debt analysis always. Thus, it would be safe for them to plan their investment
in near future more effectively. The overall capital structure must be divided on the proportion of
debts and equity as the return they are getting from them. The equity proportion must be high as
compare to the debt.
CONCLUSION
From the above project report, it has been concluded that investor need to select their right
option after evaluating the results from WACC so that chances of risk can be identified early.
Further, the gearing ratio outcomes would also be taken into considered before making
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investment as per the decided capital structure. The overall performance would also need to be
evaluated to earn maximum return in coming period of time.
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REFERENCES
Books and Journals:
Aggarwal, R. K., Meschke, F., & Wang, T. Y. (2012). Corporate political donations: investment
or agency?. Business and Politics, 14(1), 1-38.
Belloc, F. (2012). Corporate governance and innovation: A survey. Journal of Economic
Surveys, 26(5), 835-864.
Brealey, R.A., Myers, S.C., Allen, F. & Mohanty, P., (2012). Principles of corporate finance.
Tata McGraw-Hill Education.
Cumming, D. (Ed.). (2012). The oxford handbook of entrepreneurial finance. Oxford University
Press.
Derrien, F., Kecskés, A., & Thesmar, D. (2013). Investor horizons and corporate
policies. Journal of Financial and Quantitative Analysis. 48(6) 1755-1780.
Edmans, A. (2014). Blockholders and corporate governance. Annu. Rev. Financ. Econ. 6(1). 23-
50.
Flannery, M.J. & Hankins, K.W., (2013). Estimating dynamic panel models in corporate
finance. Journal of Corporate Finance. 19 pp.1-19.
Hillier, D., Ross, S., Westerfield, R., Jaffe, J. & Jordan, B., (2013). Corporate finance. McGraw
Hill.
Serfling, M. A. (2014). CEO age and the riskiness of corporate policies. Journal of Corporate
Finance, 25, 251-273.
Vernimmen, P., Quiry, P., Dallocchio, M., Le Fur, Y. & Salvi, A., (2014). Corporate finance:
theory and practice. John Wiley & Sons.
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