Analysis of Financials: Cost of Capital, Valuation, and Foreign Exchange Issues

Vodafone
Analysis of financials

2
Contents
Ans (a) Cost of capital..................................................................................................................................3
Methods of estimating cost of capital.....................................................................................................3
Calculation of cost of equity as per published financial statements........................................................4
Calculation of cost of debt as per published financial statements..........................................................4
Ans (b) Valuation of the company...............................................................................................................5
Ans (c). Foreign exchange issues related to finance raised bonds in different currencies...........................7
References.................................................................................................................................................10

3
Ans (a) Cost of capital
Methods of estimating cost of capital
A company is a combination of projects. Hence overall cost of capital as the acceptance criterion
is not suitable under all circumstances as the investment proposals varying widely in risk profile
also have widely varying returns. However for the ease of calculations we use the overall cost of
capital. The overall cost of capital is a proportionate average of the cost of different modes of
financing. The overall cost of capital consists of three components- cost of debt, cost of equity
and cost of preferred stock (Investinganswers.com, 2019).
The cost of capital is actually the rate of return that satisfies all capital providers.
Cost of Capital is the expected rate of return on various modes of financing. The overall cost of
capital is calculated as the weighted average of the individual rates of return.
Cost of Equity- The expected rate of return on investments by the common shareholders of the
company. The cost of equity is the minimum rate of return that the entity must earn on the equity
investment in order to maintain the market price of the share. If the firm invests in projects in
projects with a rate of return less than the expected return the share price will suffer in the long
run.
Cost of Debt- The rate of return of the on amount invested by the lenders of the company. This
mainly takes into consideration the long term debt of the company like term loan, bonds etc.
Other current liabilities including seasonal increase in current liabilities, working capital is
generally ignored. We assume that the firm is following a hedging strategy i.e. capital projects
are being funded by sources that are long term in nature.
Cost of Preferred Stock- Rate of return of the preference shareholders of the company. This is
calculated as the dividend paid divided by the market price of the share.
The cost of equity can be measured as the expected return on investment to keep the equity
shareholders satisfied.
As per the dividend discounting model the cost of equity is calculated as K(E)=D/P +g where D
is the dividend declared, P is the market price of the stock, g is the expected growth rate of the
company. We have assumed a constant growth model for the company. There are other models
for calculating the cost of equity. One is the Capital Asset Pricing Model which calculates the
cost of equity as the risk free rate of return plus something additional for the risk premium
depending on the sensitivity of the stock.