Corporate Finance - Admission/Application Essay Example

Corporate Finance Corporate Finance Calculating cost of equity by use of capital asset pricing model Cost of equity = risk free rate + (market rate – risk free rate) * betaThe risk free rate was 2.51 and the stock volatility is 8.0(Telstra Annual Report, 2013, 180). Therefore, the cost of equity may be computed as follows; = 2.51 + (8.0 - 2.51)* 1.9 = 2.51 + 10.431 = 12.941 = $12.94(Telstra Annual Report, 2013, 180). 2) Calculating cost of equity through use of dividend growth rate modelP = D1 / r – gWhere: P is the current stock price r – Constant cost of equity capital g – The constant growth rate of dividends D1 – value of next years dividends4.

03= D1 / 8 - 2.24.03 = D1/ 5.8. Therefore D1 = 4.03 * 5.8= $23.37.The share price used above was $4.30 for October 2012 (Telstra Annual Report, 2013, 180-184).3) The capital asset pricing model is more accurate than the dividend growth rate model. Any company can use the capital asset pricing model since it takes into account the riskiness of any investment regardless of its dividend size or dividend growth rate. In addition, the model relies on past performance of stocks to predict future outcomes which is very important to any investment.

Dividend growth rate on the other hand is less appropriate as companies that pay dividends can only use it. The model also assumes that dividends grow at a constant rate over some period and does not put into consideration the investments riskiness, which might be erroneous (Khan and Jain, 2004, 113-115). The weighted cost of capital (WACC) = D/D+E * Kd + E/D+E * Ke may be used to determine the discount rate. Where; D represents the total debt, E represents the total shareholders’ equity, Kd is the cost of debt and Ke the cost of equity ((Telstra Annual Report, 78-80).

Therefore, WACC = 15064/ (15064+12875) * 1777.36 + 12875/ (15064+12875) * 5793 =15064/ 27939 *1777.36 + 12875/ 27939 *5793 =0.539 * 1777.36 + 0.461 * 5793 = 3628.57 = $3,628.574) Future projects of the company will yield much higher benefits than the current projects. The dividend growth rate model above has clearly indicated this. Optimal capital structure is the maintenance of a balance between debts to equity ratio of a company while minimizing the cost of capital.

Increase in cost of debt means an increase in riskiness of the company. Any profitable organization should strive in maximizing cost of debt and minimize the cost of capital as these results to high returns (Brigham and Daves, 2013, 102-135). The management of the company knowing the cost of debt and capital will help them balance the debt to equity ratio to realize optimum capital structure. (Brigham and Daves, 2013, 120-125). argued that existence of optimal capital structure ensures maximization of the value of the firm.

Optimal capital structure has the desired amount of debt which helps minimize cost of capital. Therefore, managers knowing the cost of debt and capital will help them control the amount of debt and capital to realize the desired optimal capital structure. When the managers are aware of the cost of debt and capital it becomes easier for them determine the optimal capital structure that maximizes shareholders wealth. With the costs of debt and capital, managers are able to estimate the total shareholders wealth (Khan and Jain, 2004, 125-146).

ReferencesBrigham, E. F., and Daves, P. R. Intermediate financial management. Mason, Ohio: Southwestern, 2013.Khan, M. Yand Jain, P. K. Financial management; Text, problems and cases. New Delhi: Tata McGraw-Hill, 2004.Telstra Annual Report. Annual Report 2013. Accessed September 9th 2014.:.2013.