I need help with OCS project. Please see attached.

OCS Assignment This assignment follows from your previous WACC project. Here, you must determine what the optimum capital structure is for your firm. A sample spreadsheet is provided where you may input the data that you have already found for the WACC. The spreadsheet will use Hamada's Equation to recalculate the levered betas based on the weights that you choose. NOTE: You cannot just assume that your weights and your bond values are the same as the sample. You must choose the appropriate weights first based on the market value weights your firm currently has. Then, you must choose appropriate bond rates as you increase or decrease the weight for debt. You must explain and reference how you chose your numbers and attach a copy of the spreadsheet. Note that the spreadsheet has all the calculations for the WACC on the top portion, but Hamada's Equation only uses the CAPM to refigure the levered beta and the new WACC for that beta. Complete the OCS project according to the assignment instructions. For example: Complete a table similar to Figure 155 in the textbook Use the "Sample Combination WACC and OCS Spread Sheet" as a model Your table will likely not be identical since it depends on what your capital structure is now What was the existing capital structure for your firm? Do you believe it was optimum? Use Hamada's equation to determine the optimum Should your company take on more debt, repurchase stock, have a seasoned equity offering? Justify your answers Tool Kit for Capital Structure Decisions Optimum Capital Structure Problem (Millions of Dollars Except Per Share Data) NUMBERS IN RED MUST BE INPUTTED, NUMBERS IN BLUE ARE CALCULATED Input Data (Millions Except Per Share Data) Tax rate Debt (D) Number of shares (n) Stock price per share (P) 39% $2,119,560,000.00 728,100,000 $12.81 Capital Structure (Millions Except Per Share Data) Market value of equity (S = P n) Total value (V = D + S) Percent financed with debt (wd = D/V) $9,326,961,000.00 $11,446,521,000.00 18.5% Percent financed with stock (ws = S/V) 81.5% Cost of Capital Cost of debt (rd) Beta (b) Risk-free rate (rRF) 3.26% 1.14 Market risk premium (RPM) 6.54% 2.87% Cost of equity (rs = rRF + b RPM ) 10.31% Cost of Equity from Dividend Growth Model Future Dividend Growth Rate Last Dividend $ Share Price $ (4/5/13) 10.60% 0.0345 12.81 Cost of Equity from Dividend Growth Model Cost of Equity from Bond Plus Markup Cost of debt Risk Markup Cost of Equity from Bond Plus Markup Average rs WACC $ 10.90% 3.26% 7.20% 10.46% 10.6% 8.97% ESTIMATING THE OPTIMAL CAPITAL STRUCTURE The optimal capital structure is the one that maximizes the value of the company. Also, that same capital structure minimizes debt and equity. The effects on debt are usually estimated by talking with bankers and investment bankers. Discussions with i more it borrows, the higher the cost of its debt. Note: the percentages are based on market values. Estimating Optimal Capital Structure (Millions of Dollars) Percent of Firm Financed with D 10% 15% 20% 1. ws 90.00% 85.00% 80.00% 2. 3. 4. rd b rs 2.80% 1.07 3.00% 1.11 3.26% 1.15 9.85% 10.11% 10.41% 5. 6. rd (1T) WACC 1.71% 9.04% 1.83% 8.87% 1.99% 8.72% Notes: 1. The percent financed with equity is: ws = 1 wd 2. The interest rate on debt, rd, is obtained from investment bankers. 3. The levered beta is estimated using Hamada's formula, and unlevered beta of b U = x and a tax rate of 39%: b = b U [1 + (1-T) (wd/ws)]. 4. The cost of equity is estimated using the CAPM formula with a risk-free rate of 2.87% and a market risk premium of 6.54%: r s = rRF + (RPM)b. 5. The after-tax cost of debt is rd (1T), where T = 39%. 6. The weighted average cost of capital is calculated as: WACC = ws rs + wd rd (1-T). THE HAMADA EQUATION Hamada developed his equation by merging the CAPM with the Modigliani-Miller model. We use the model to determine beta debt ratios to find the cost of equity associated with those debt ratios. Here is the Hamada equation: b b = bU x [1 + (1-T) x (D/S)] = bU x [1 + (1-T) x (wd/ws)] bU = b / [1 + (1-T) x (wd/ws)] Here b is the leveraged beta, bU is the beta that the firm would have if it used no debt, T is the marginal tax rate, D is the mar Levered beta, b Current wd 1.14 19% Current ws 81% 39% Tax rate bU 1.0012 As shown above, beta rises with financial leverage. With beta specified, we can determine the effects of leverage on the cost Data From: Data From hat same capital structure minimizes the WACC. We begin by estimating how capital structure affects the costs of nvestment bankers. Discussions with its bankers indicate that Strasburg can borrow different amounts, but the ket values. Percent of Firm Financed with Debt (wd) 25% 30% 35% 40% 75.00% 70.00% 65.00% 60.00% 3.50% 1.20 4.00% 1.26 5.00% 1.33 5.75% 1.41 10.74% 11.12% 11.56% 12.07% 2.14% 8.59% 2.44% 8.51% 3.05% 8.58% 3.51% 8.64% unlevered beta of b U = x h a risk-free + (RPM)b. We use the model to determine beta at different amount of financial leverage, and then use the betas associated with different a equation: T is the marginal tax rate, D is the market value of the debt, and S is the market value of the equity. ne the effects of leverage on the cost of equity. associated with different Running Head: WACC Project: The Cooper Companies, Inc. 1 WACC Project: The Cooper Companies, Inc. Table of Contents Introduction/Background.................................................................................................................3 Equations with Data and Brief Description.....................................................................................4 WACC..............................................................................................................................................4 Running Head: WACC Project: The Cooper Companies, Inc. 2 Beta..................................................................................................................................................4 Cost of Preferred Stock....................................................................................................................5 Cost of Debt.....................................................................................................................................5 Market Value of Equity...................................................................................................................5 Market Value of Debt......................................................................................................................5 Corporate Tax Rate..........................................................................................................................6 Required Return on Preferred Stock................................................................................................6 Calculation of Weights of Equity and Debt.....................................................................................6 Weight of Equity..............................................................................................................................6 Weight of Debt................................................................................................................................6 Cost of Equity and Debt...................................................................................................................7 Assumptions.....................................................................................................................................7 Discounted Cash Flow.....................................................................................................................7 Value of RF......................................................................................................................................7 Appendix.........................................................................................................................................7 Reference.........................................................................................................................................8 Introduction / Background The Cooper Companies, Inc. has two divisions: CooperVision and CooperSurgical. CooperVision primarily manufactures vision related products such as soft contact lenses. The other division is CooperSurgical. They manufacture various medical devices from simple to sophisticated equipment and tools primarily in women's health care. I chose this company for Running Head: WACC Project: The Cooper Companies, Inc. 3 this project because I deal with their product on a daily basis at work. Working in a decent-sized Optometrist's office, our practice is a one-stop shot for all vision related problems. The doctor checks the health of eyes and the changing vision of patients and staff including myself sell either contact lenses or glasses. If you are a contact lens wearer, you may have heard of CooperVision's steady-selling contact lenses called Biofinity. One of the job descriptions of my position includes selling contact lenses. It certainly makes it easy to sell when the product has high quality and is continuously improving. As a contact lens wearer, they are one of the best spherical contact lenses I experienced and I built my interest in their company due to their excellent products and marketing. The Cooper Companies, Inc. is publicly traded company on the NYSE with the symbol of COO. Healthcare industry has had a tremendous growth in the recent years especially with growing technology. The industry is sensitive to changes and demands of its clients whether they are clinicians or patients. As a result, healthcare related companies such as the Cooper Companies, Inc. have to be at its front in innovative products to stay on top. They are constantly launching new products such as newly designed contact lenses with increased comfort. Every project such as a new product launch will require the company to look into many factors such as the cost of capital. This paper will detail in their weighted average cost of capital. Equations with Data and Brief Descriptions Weighted Average Cost of Capital (WACC) Sources of company capital can vary. The two sources of capital are equity and debt. Issuing equity stock and preferred stock generates the equity form of capital. Borrowing cash from banks or issuing bonds will increase debts. All the different sources of capital carry Running Head: WACC Project: The Cooper Companies, Inc. 4 different cost. The cost of equity capital is dividend whereas the cost of borrowed capital or debts is in form of interest, which is fixed in nature. WACC is a technique that calculates the cost of capital as a whole by assigning weights to various sources of capital and gives a number about the cost of capital, which is in terms of percentage. If WACC is higher, it is an indication of higher risk associated with the company. The formula used to calculate WACC is given below: WACC = [(wE) x RE] + [(wPF) x RPF] + [(wD) x RD x (1- TC)] The calculation of WACC is shown in the appendix. The WACC of Cooper Companies, Inc. comes to be at 8.55% which is not too high and is at a moderate level. It suggests that the company is not spending too much cost for sourcing the capital. Beta Beta measures the volatility of the share to stock market. If beta is more than 1 it means that the stock is more volatile than market whereas a beta of less than 1 is considered good which means that the stock is less volatile to market movement. The beta is calculated using regression as well as it is also taken from two different sources. Beta Calculated: 0.54 Beta Yaoo.com: 0.54 Beta Google.as: 0.53 The beta taken for the purpose of calculation of WACC is the average of the three betas discussed above. Cost of Preferred Stock The company has not issued any preferred stock; hence there is no cost of preferred stock. Cost of Debt Running Head: WACC Project: The Cooper Companies, Inc. 5 The cooper companies, Inc. has not issued any bonds and I have checked morningstar.com which does not provides any data on bonds. To ascertain the cost of debts the interest expense is taken and is divided by total debts of the company. The debts are calculated using Form 10-K of the company for fiscal year 2015. The calculation of cost of debt is given under: Debts of the company: $1,349.96 million Interest expense of company: $18.103 million Cost of debt = (Interest expense/Total Debts)*100 = ($18.103/1,349.96)*100 = 1.34% Market Value of Equity As per Form 10-K of company the company has 42.268 million shares and the share is presently trading at $162.12. Therefore the total market value of the equity comes to be $6,852.49 (42.268*$162.12). Market Value of Debt It is also taken from Form 10-K of the company. The market value of debt includes longterm debts and short-term debts and comes at $1,349.96 million. Corporate Tax Rate The corporate tax rate of the company is also taken from Form 10-K. It is given as effective tax rate in Form 10-K. The corporate tax rate is too low at 4.80%, the average tax that the company has paid during the year. It is borrowed from Form 10-K for the fiscal year 2015. The corporate tax rate of the company comes to be at 30.30%. Required Return on Preferred Stock Running Head: WACC Project: The Cooper Companies, Inc. There are no preferred stocks; hence no return on preferred stock. Calculation of Weights of Equity and Debts Total Equity $6,852.49 Total Debts $1,349.96 Total Debts and Equity $8,202.46 Weight of Equity The formula for calculating weight of equity is: Market value of equity/(Market value of equity + Total value of Debts) = $6,852.49/$8,202.46 =83.54% Weight of Debt The formula for calculating weight of debt is: Total Debts/(Market value of equity + Total debts) = $1,349.96/$8,202.46 = 16.46% Cost of Equity and Debt CAPM is a technique used to calculate cost of equity. The formula used to calculate cost of equity is Rs = RRF + (RM - RRF)b. Risk free market rate is taken at 2.39% which is the 10 year Treasury bond rate. The market rate of return of the company is taken to be 7.50%, which is taken as the safest return. Assumptions 6 7 Running Head: WACC Project: The Cooper Companies, Inc. Discounted Cash Flow (DCF) The calculation of discounted cash flow is made on the basis of the dividend distributed by the company. The company has start-distributing dividend from 2013. So the calculations are performed considering discount of three years in appendix. The date of 10 years is not available. Value of RF RF is the rate of U.S. Treasury bond with a maturity of 10 years. Appendix Weights for the WACC Value Of Equity 42.268*162.12 = Value Of debt Weight Of Debt Weight Of Equity Cost of Equity (RE) Cost Of Debt (Rd) Tax Rate (Tc) $6,852.49 Million $1,349.96 Million 16.46% 83.54% 9.98% 1.34% 4.80% 1,602 4,923 WACC = [(wE) x RE] + [(wD) x RD x (1- TC)] Cost Cost of Equity (RE) Cost Of Debt (Rd) 9.98% 1.34% Weight Weighted Cost 83.54% 16.46% WACC Reference Brigham, E. F., & Earhardt, M. C. (2015). Financial Management Theory and Practice (15th ed.). Boston, MA: Cengage Learning. Bonds and Rates. (2016, December 2). Retrieved December 04, 2016, from http://money.cnn.com/data/bonds/ Cooper Companies Inc. (2016, December 2). Retrieved December 04, 2016, from http://www.google.com/finance?cid=8822 8.34% 0.21% 8.55% Running Head: WACC Project: The Cooper Companies, Inc. The Cooper Companies A Quality of Life Company [Brochure]. (2015). Retrieved December 4, 2016, from http://www.coopercos.com/media/CooperCompaniesBrochureNovember2015.pdf The Cooper Companies, Inc. (Rep. No. 10K). (2015, December 18). Retrieved December 4, 2016, from The Cooper Companies, Inc. website: http://investor.coopercos.com/secfiling.cfm? filingID=711404-15-21&CIK=711404 The Cooper Companies, Inc. (COO). (2016, December 2). Retrieved December 4, 2016, from https://finance.yahoo.com/quote/COO?ltr=1 8