Use Sample Combination WACC and OCS Spread Sheet.

Complete the OCS project according to the assignment instructions. For example: ?Complete a table similar to Figure 15-5 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

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 Panel a: Operating Leverage Panel b: Financial Leverage Plan A Break-even Q 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) Data From 3.26% 1.14 Beta (b) Risk-free rate (rRF) 2.87% Market risk premium (RPM) Cost of equity (rs = rRF + b RPM ) 6.54% 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. rd 3. 4. 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. rd (1T) 6. 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: 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. Thaddeus Ezeh-WACC Project WEIGHTED AVERAGE COST OF CAPITAL PROJECT FOR \"DOW CHEMICALS\" Thaddeus Ezeh-WACC Project Introduction The Dow Chemical Company is engaged in manufacturing and supplying of products which are primarily used as raw materials for the manufacture of the customer products and services across the world. It moves its business through Agricultural Sciences, Consumer Solutions, Solutions for any kind of infrastructure, Performance of Chemical & Material and Performance Plastic Segments. The basic idea from the agricultural Sciences is to protect the crops and plant / seed biotechnology technologies and products, pest management solutions at the urban level along with healthy oils herbicides, seeds, fungicides etc. The contribution by the Consumer Solution Segment is semi-conductors along with diodes in the form of light-emission, adhesives and foams that are generally used by the transpiration industry. The company also manufactures different of Cellulosics for formulations in the Pharmaceutical industry and the food solutions. Dow also caters to the automotive, electronic, healthcare, home care, personal and medical segment as well. The Infrastructure Solutions Segment offers architectural and industrial coating applications, building insulations, adhesives, products of microbial protection that are used in the oil & gas industry, purification of water , Separation technologies like reverse osmosis membranes etc. The performances Material and Chemicals segment offers Caustic Soda and Chorine, intermediate, industrial solutions etc. The Performance Plastics Segment offers elastomers, Wire and Cable insulation, Semi conductive, and Jacketing Compounding Solution. Overall we may say that, The Dow Chemical Company is engaged in manufacturing and supplying of variety of products to cater the human needs. The company was established during the year 1897 and is having its head quarter at Midland Michigan. Over the 118 years, Dow has continued to prosper and evolve by generating lasting value in building of competitive advantage and always fosters its efforts to maximize the returns of the Thaddeus Ezeh-WACC Project shareholders. In order to continue the accomplishment, the company is always leveraging its strength in order to accelerate its growth overall the entire gamut of integrated portfolio. The company has the habit of collaborating closely with all the customers in order to in order to deliver better solutions that are very profitable in nature. The company always ensures that it resolute in its commitments to the promised stakeholders. Dow is strengthening itself for now and for the future by capturing the full potential in order to optimize all the sustainable business innovations and results which are needed by the customer and the world. The company has vision of Maximizing long-term value per share. The company has a very strong strategy for all the products it dealing with till date. The uniform strategy of the company for almost all the products to position them in their respective field is very vital. The low-cost leaded strategy adopted by the company is very crucial and the company has become a benchmark in the industry in this regard. It is actually very difficult to win in today's volatile market as the global market place needs a healthy and sound strategy with disciplined execution. Building on the strength of Dow, it continues to accelerate its market driven ideas, which is going narrower with deeper strategically alignment in the end markets by increasing productivity across integrated value chains and ensuring that the value of the investment is maximized. Over the many integrated portfolio of the company, there are number of strategic actions which will deliver the highest value from each and every business. The company is elevating it's cost position and the value of the it's integration, while in the similar times, it is prioritizing investments in innovation, commercialization, multigenerational solutions etc which bring value to the customer and the Dow as well. With a conservative eye towards the value, the company is preferred to exit non-strategic along with all the capital - intensive businesses. Dow's strong performances in the recent years have recorded many achievements and have enabled the Thaddeus Ezeh-WACC Project company to accelerate its shareholder focused specific events. In a collective basis, the company continues to pull the strategic, operational and financial levers in order to control the market uncertainty and ensuring the increased results year on year. Weighted Average Cost of Capital is a very important for any kind of organization and an accurate weighted cost of capital is pretty essential. I have made an attempt to understand the Weighted Average Cost of Capital of Dow Chemical as mentioned below: Cost of Equity (Common Stock) The Value of Beta from the Regression Analysis The Value of Beta from Yahoo Finance The Value of Beta from Google Finance Average Beta Value for DOW = = = = 2.036 0.63 1.62 1.43 In view of the above different Beta Values, we may be pleased to take the average Beta Value in order to have a conservative decision. So the Beta to be used for the CAPM is 1.43. As per Capital Pricing Model (CAPM), Cost of Equity = = = Risk Free Rate + Beta * (Return From Market - Risk Free Rate) 2.25% + 1.43 * (13.69% - 2.25%) 18.59% Risk Free Rate Return from market Beta https://in.finance.yahoo.com/q?s=DOW http://www.google.com/finance?cid=665819 http://www.investing.com/rates-bonds/u.s.-10-year-bond-yield http://quicktake.morningstar.com/index/IndexCharts.aspx?Symbol=SPX Cost of Preferred Stock = 2.25% = = 13.69% 1.43 Thaddeus Ezeh-WACC Project Preferred Stock Dividend as on December 31, 2014 Total Preferred Stock Value as on December 31, 2014 Cost of Preferred Stock = = = $ 340 Millions $ 4,000 Millions (340/4000)*100 8.50% Total Long Term Debt as on December 31, 2014 Total Interest Expenses as on December 31, 2014 Cost of Debt Before Tax Adjustment = = = $ 18,838 Million $ 983 Million (983 / 18838)*100 5.22% Income Before Income Taxes as on December 31, 2014 Provision for income taxes as on December 31, 2014 Tax Rate as on December 31, 2014 = = = $ $ Cost of Debt 5,265 Millions 1,426 Millions 27.08% Weighted Average Cost Of Capital (WACC) WACC for Dow Chemical's = Weight of Equity in total Capital * Cost of Equity + Weight of Debt Capital * Cost of Debt * (1 - Tax Rate) Weight of Preferred Capital * Cost of Preferred Capital = 45.87% * 18.59% + 44.65% * 5.22% * (1-27.08%) +9.48% *8.50% = 11.03% Total Equity Capital (Excluding Preferred) Total Debt Capital Total Preferred Capital Total Capital of Dow Chemicals = = = = $ $ $ $ 19,354 18,838 4,000 42,192 Weights of Equity Capital in total capital structure of DOW Weights of Debt Capital in total capital structure of DOW Weights of Preferred Capital in total capital structure of DOW = = = Cost of Equity Cost of Debt Cost of Preferred = = = 18.59% 5.22% 8.50% Tax Rate = 27.08% 45.87% 44.65% 9.48% Million Million Million Million Thaddeus Ezeh-WACC Project How much do you think the stock market will return over and above the Treasury10 year bond rate? Ans: The average return from the S&P 500 index over the many years is 13.69%. The Treasure 10 year bond rate is 2.25%. So the return of the stock market over and above the Treasury 10 year bond rate = 11.44% References http://quicktake.morningstar.com/index/IndexCharts.aspx?Symbol=SPX http://www.investing.com/rates-bonds/u.s.-10-year-bond-yield As an investor, that is an important question to answer before you invest in the stock market? Ans: As an investor, it should be understood what is maximum return he/she can get before he / steps to invest, so that the planning for investment can be accordingly. Do you think it will return enough to justify the added risk? Ans: The additional return of 11.44% on and above the 10 year Treasury Bond rate is sufficient to justify the added risk. Do you think this premium will vary for different countries or for the same country over different time spans? Ans: This premium of 11.44% will differ from country to county due to the different risk appetite