Capital Structure and WACC Analysis of Fortescue Metals Group Limited

This report analyzes the capital structure and WACC of Fortescue Metals Group Limited. It includes the calculation of WACC for the years 2014-2017 and the debt equity ratio of the firm. The report also provides recommendations based on the analysis.

Running head: FINANCIAL MANAGEMENT
Financial Management
Student Name
University Name

2FINANCIAL MANAGEMENT
Table of Contents
Introduction......................................................................................................................................3
Question 1: Determination of WACC.............................................................................................3
Question 2: Nature of firm’s capital structure.................................................................................7
Conclusion.......................................................................................................................................8
References........................................................................................................................................9

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Introduction
The below report highlights the capital structure of the firm Fortescue Metals Group Limited. It
is one of the leading iron ore production and exploration company which operates in the Pilbara
region of northern Western Australia. Based on the last financial years, the capital structure of
the firm will be determined and on that basis, several recommendations will be given to the firm.
Question 1: Determination of WACC
The cost of capital comprises of overall cost of equity and debts fund of a particular
organization. It is also considered as the required rate of return of the given organizations.
Weighted Average Cost of Capital helps in determining the capital structure of the firm (Robb
and Robinson 2014)
It can be inferred that all sources of capital, including debt, equity, bonds are included in the
calculation of Weighted Average Cost of Capital. The WACC of an organization increases as the
rate of return of equity of an organization increases (Zeitun and Tian 2014). The following
tables will reflect the calculation of WACC of the firm Fortescue Metals Group Limited.
Cost of Equity Amount of Equity
Riskfree rate 2.39% Share
s
3111
Bet
a
0.90 Price 5.22
Market return 10% Value 16239.4
2
Cost of Equity 9.38%
Cost of Debt Amount of Debt
Rat
e
2.75% Book value 12257

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Tax
rate
30% Adjustment 1
Cost of Debt 1.93% Value 12257
Total Capital 28496.4
2
WACC 6.18%
Calculation of WACC for the year 2017
(Source: Created by Author)

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Cost of Equity Amount of Equity
Riskfree rate 2.88% Shares 3113
Beta 0.90 Price 3.5
Market return 8% Value 10895.5
Cost of Equity 7.16%
Cost of Debt Amount of Debt
Rate 2.88% Book value 8992
Taxrate 30% Adjustment 1
Cost of Debt 2.02% Value 8992
Total Capital 19887.5
WACC 4.84%
Calculation of WACC for the year 2016
(Source: Created by Author)
Cost of Equity Amount of Equity
Risk free rate 3.42% Share
s
3113
Beta 0.90 Price 1.91
Market return 7% Value 5945.83
Cost of Equity 6.59%
Cost of Debt Amount of Debt
Rate 3.42% Book value 9813
Tax
rate
30% Adjustment 1
Cost of Debt 2.39% Value 9813
Total Capital 15758.83
WACC 3.98%
Calculation of WACC for the year 2015
(Source: Created by Author)
Cost of
Equity
Amount
of
Equity
Riskfree
rate 3.45% Shares 3113
Beta 0.90 Price 4.35
Market 5% Value 13541.55

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return
Cost of
Equity 4.49%
Cost of
Debt
Amount
of Debt
Rate 2.88% Book value 9981
Tax rate 30% Adjustment 1
Cost of
Debt 2.02% Value 9981
Total
Capital 23522.55
WACC 3.44%
Calculation of WACC for the year 2014
(Source: Created by Author)
From the above analysis, it can be inferred that WACC of the firm has increased over the past
few years. This further implies that rate of return on equity of the firm has increased, which can
be considered as a positive sign for the firm (Zeitun and Tian 2014). It also implies that the
capital structure of the firm Fortescue Metals Group Limited is less risky and has improved over
the years. However, in comparison to industry average, WACC is on the lower side, which can
be considered as a negative sign for the firm. In addition to this, it can be also inferred that the
share capital of the firm has increased over the years. This can be considered as a positive sign
for the firm.

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Question 2: Nature of firm’s capital structure
The nature of capital structure of the firm can be evaluated with the help of debt equity ratio of
the firm. This ratio measures the percentage of debt over equity of the firm. An ideal debt equity
ratio is 2:1 (Peirson et al. 2014).
2013 2014 2015 2016 2017
Equity 5,702,425,876 8,049,893,842 9,813,802,083 11,319,687,58
4
12,654,706,18
8
Debt 13,461,994,60
9
9,981,953,290 12,257,812,50
0
8,992,728,252 5,655,226,209
2.360748724 1.24001055 1.249038079 0.794432548 0.4468872
Table 1: Overview of Debt equity ratio of the firm Fortescue Metals Group
From the above analysis, it can be inferred that the debt equity ratio of the firm has declined over
the years. In the year 2017, debt equity ratio of the firm is 0.44. This infers that 44 percent of the
total capital is financed by debt and the rest 66 percent is financed by equity. This infers that firm
is exposed to less amount of risk in 2017 in comparison to previous years. There are several
determinants of capital structure of the firm (Albul, Jaffee and Tchistyi 2015). These are:-
 Tax exposure-The organization is exposed to tax exposure, therefore, it is important for
the firm to minimize the debt in comparison with the previous years.
 Financial flexibility – It has been seen that the primary objective of the firm to attain
155million tones production. Therefore, it is important for the firm to be financially
stable. Therefore, the debt portion of the firm has declined to make the capital structure
risk free.

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 Growth Rate- It is important for the firm to improve the growth rate and its cost of
capital and return on equity. Due to this reason, more portion has been kept for equity and
less of debt.
From the above analysis, it can be deduced that the above factors play an important role in
the determining the capital structure of the firm. In addition to this, it has been also seen that
the percentage of Total liabilities to shareholders’ equity of the firm has declined. This can
also be considered as a positive sign for the firm.
Conclusion
From the above analysis, it can be inferred that the WACC of the firm has increased over the
years. This reflects the percentage of ownership capital has also increased and financial leverage
of the firm Fortescue Metals Group has declined considerably. In addition to this, the debt equity
ratio of the organization has declined which provides further financial flexibility to the
organization.

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References
Albul, B., Jaffee, D.M. and Tchistyi, A., 2015. Contingent convertible bonds and capital
structure decisions.
Peirson, G., Brown, R., Easton, S. and Howard, P., 2014. Business finance. McGraw-Hill
Education Australia.
Robb, A.M. and Robinson, D.T., 2014. The capital structure decisions of new firms. The Review
of Financial Studies, 27(1), pp.153-179.
Zeitun, R. and Tian, G., 2014. Capital structure and corporate performance: evidence from
Jordan.