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.

Company is Sony

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. 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) Data From: 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% Data From 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 10.90% Cost of Equity from Bond Plus Markup Cost of debt Risk Markup Cost of Equity from Bond Plus Markup 3.26% 7.20% 10.46% 10.6% Average rs WACC 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 the WACC. We begin by estimating how capital structure affects the costs of debt and equity. The effects on debt are usually estimated by talking with bankers and investment bankers. Discussions with its bankers indicate that Strasburg can borrow different amounts, but the 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 Debt (wd) 10% 15% 20% 25% 30% 35% 40% 1. ws 90.00% 85.00% 80.00% 75.00% 70.00% 65.00% 60.00% 2. 3. 4. rd b rs 2.80% 1.07 3.00% 1.11 3.26% 1.15 3.50% 1.20 4.00% 1.26 5.00% 1.33 5.75% 1.41 9.85% 10.11% 10.41% 10.74% 11.12% 11.56% 12.07% 5. 6. rd (1T) WACC 1.71% 9.04% 1.83% 8.87% 1.99% 8.72% 2.14% 8.59% 2.44% 8.51% 3.05% 8.58% 3.51% 8.64% 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 = bU [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 at different amount of financial leverage, and then use the betas associated with different debt ratios to find the cost of equity associated with those debt ratios. Here is the Hamada equation: debt ratios to find the cost of equity associated with those debt ratios. Here is the Hamada equation: b = bU x [1 + (1-T) x (D/S)] b = 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 market value of the debt, and S is the market value of the equity. 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 of equity. Weights for the WACC Value Of debt Value of Debt Long Term Lease Total Value of Debt Value Of Equity Common shares Market Price Market Value of Equity $556.30 Million $405.21 Million $961.51 Million Weight Of Debt Weight Of Equity 3.027% 96.97% Cost of Equity (RE) 5.33% Cost Of Debt (Rd) 2.05% Tax Rate (Tc) 36.00% WACC = [(wE) x RE] + [(wD) x RD x (1- TC)] Cost Weight Weighted Cost 5.33% 96.97% 5.16% 2.05% 3.03% 0.06% Cost of Equity (RE) Cost Of Debt (Rd) WACC 5.23% 1.17 Billion $26.33 30.8061 Billion Value of RF Beta Sony Corp 1.64969 CAPM CAPM: RE = RRF + (RM - RRF)b RE = 5.33% Value of RM 1.30% 3.74% Date S&P SNE 10/6/2010 1183.26 11/1/2010 1180.55 12/1/2010 1257.64 1/3/2011 1286.12 2/1/2011 1327.22 3/1/2011 1325.83 4/1/2011 1363.61 5/2/2011 1345.2 6/1/2011 1320.64 7/1/2011 1292.28 8/1/2011 1218.89 9/1/2011 1131.42 10/3/2011 1253.3 11/1/2011 1246.96 12/1/2011 1257.6 1/3/2012 1312.41 2/1/2012 1365.6801 3/1/2012 1408.47 4/2/2012 1397.91 5/1/2012 1310.33 6/1/2012 1362.16 7/2/2012 1379.3199 8/1/2012 1406.58 9/4/2012 1440.67 10/1/2012 1412.16 11/1/2012 1416.1801 12/3/2012 1426.1899 1/2/2013 1498.11 2/1/2013 1514.6801 3/1/2013 1569.1899 4/1/2013 1597.5699 5/1/2013 1630.74 6/3/2013 1606.28 7/1/2013 1685.73 8/1/2013 1632.97 9/3/2013 1681.55 10/1/2013 1756.54 11/1/2013 1805.8101 12/2/2013 1848.36 1/2/2014 1782.59 2/3/2014 1859.45 3/3/2014 1872.34 4/1/2014 1883.95 5/1/2014 1923.5699 6/2/2014 1960.23 7/1/2014 1930.67 8/1/2014 2003.37 9/2/2014 1972.29 10/1/2014 2018.05 11/3/2014 2067.5601 12/1/2014 2058.8999 1/2/2015 1994.99 2/2/2015 2104.5 3/2/2015 2067.8899 4/1/2015 2085.51 5/1/2015 2107.3899 6/1/2015 2063.1101 7/1/2015 2103.8401 8/3/2015 1972.1801 9/1/2015 1920.03 10/1/2015 1987.05 S&P Return SNE Return 33.84 35.48 35.71 34.34 36.84 31.83 28.31 26.74 26.39 25.1 21.95 19 20.97 18.05 18.04 18.22 21.39 20.77 16.21 13.24 14.24 12.15 11.31 11.7 11.74 9.74 11.2 14.94 14.58 17.4 16.43 20.15 21.19 21.04 19.96 21.52 17.25 18.3 17.29 15.75 17.55 19.12 17.64 16.18 16.77 18.43 19.11 18.04 19.82 21.99 20.47 23.29 28.32 26.78 30.23 30.92 28.39 28.35 25.78 24.5 26.49 SUMMARY OUTPUT -0.23% 6.53% 2.26% 3.20% -0.10% 2.85% -1.35% -1.83% -2.15% -5.68% -7.18% 10.77% -0.51% 0.85% 4.36% 4.06% 3.13% -0.75% -6.27% 3.96% 1.26% 1.98% 2.42% -1.98% 0.28% 0.71% 5.04% 1.11% 3.60% 1.81% 2.08% -1.50% 4.95% -3.13% 2.97% 4.46% 2.80% 2.36% -3.56% 4.31% 0.69% 0.62% 2.10% 1.91% -1.51% 3.77% -1.55% 2.32% 2.45% -0.42% -3.10% 5.49% -1.74% 0.85% 1.05% -2.10% 1.97% -6.26% -2.64% 3.49% 4.85% 0.65% -3.84% 7.28% -13.60% -11.06% -5.55% -1.31% -4.89% -12.55% -13.44% 10.37% -13.92% -0.06% 1.00% 17.40% -2.90% -21.95% -18.32% 7.55% -14.68% -6.91% 3.45% 0.34% -17.04% 14.99% 33.39% -2.41% 19.34% -5.57% 22.64% 5.16% -0.71% -5.13% 7.82% -19.84% 6.09% -5.52% -8.91% 11.43% 8.95% -7.74% -8.28% 3.65% 9.90% 3.69% -5.60% 9.87% 10.95% -6.91% 13.78% 21.60% -5.44% 12.88% 2.28% -8.18% -0.14% -9.07% -4.97% 8.12% Regression Statistics Multiple R 0.472938915 R Square 0.2236712173 Adjusted R Square 0.2102862383 Standard Error 0.1009906101 Observations 60 ANOVA df Regression Residual Total Intercept X Variable 1 1 58 59 SS MS F Significance F 0.1704332785 0.1704332785 16.71061397 0.0001356927 0.5915479927 0.0101991033 0.7619812712 Coefficients Standard Error t Stat P-value -0.0127605739 0.0135392783 -0.9424855313 0.3498534289 1.6191648865 0.3960909081 4.0878617846 0.0001356927 Lower 95% Upper 95% Lower 95.0% Upper 95.0% -0.039862384 0.0143412362 -0.039862384 0.0143412362 0.8263027904 2.4120269825 0.8263027904 2.4120269825 Name Sony 2.068% Sony 2.004% Weighted average RD = Maturity Date Amount $(Mil) 6/20/2019 12/20/2018 419.5 136.8 1.56 + 0.49 YTM % 2.068 2.004 2.05% Size (bil) Weight 50.00 16.30 0.75 0.25 Weight YTM 1.56 0.49