Review the 1) dividends for the past three years and 2) capital structure of the company you have been researching for your SLP assignment. Then answer the following questions in a Word document (except for the Excel portion specifically noted). The paper should be 2 pages in length.
LEVERAGE, CAPITAL STRUCTURE, AND DIVIDEND POLICY
Required Reading
Please read through the following book chapters. Pay special attention to the concepts of operating leverage, financial leverage, business vs. financial risks, and the major theories of capital structure choices.
Vishwanath, S. (2007). Chapter 19: Optimal capital structure. Corporate finance: Theory and practice. SAGE Publications India. Available in the Trident Online Library.
Finally, take a look at the following book chapter on dividend policy. Take a close look at the concepts of regular dividend policy and low-regular-and-extra dividend policy, as well as stock splits and stock repurchases:
Clive, M. (2012). Chapter 15: Dividend policy. Financial management for non-financial managers. Kogan Page. Available in the Trident Online Library.
Running Head: THE COST OF CAPITAL
Running Head: THE COST OF CAPITAL
4
Module 3 SLP: The Cost of Capital
Tesla’s Credit Rating
On 9 December 2020, the ratings as per
Fidelity Fixed Income
improved to ‘BB,’ from ‘BB-‘ awarded in October 2020. This was because its liquidity was mounting. Thus, the outlook remained positive. At this time, the company had completed the sale of its common stock worth $5 billion, Tesla had also raised cash worth 7.3 billion through its previous sale of shares in the year. This made its mounting liquidity substantially reduce its financial risk.
Just like in October, the company continued to improve the execution of operations, production became more efficient, and its global expansion moves increased. The increase shows that the outlook has been optimistic. There is a one-third probability that the rating could improve in the next year if the company’s competitive advantage remains strong.
The current return for a 30-year bond for a corporation (RD)
According to
the Fidelity Fixed Income
Web page, Tesla Inc. is categorized under Baa/BBB since its credit rating is BB. The highest yield for a 30-year bond for corporations is 5.48%, and the median result for a 30-year bond for a corporation is 2.99%. Tesla is a high yield corporate bond classified below BBB. The 30-year bond for the corporation is thus 5.48%.
Cost of equity for Tesla (RE)
The Beta for Tesla Inc., according to yahoo finance, was established as 2.15, which is 5yr monthly. The three-month Treasury bill yield for the company is 0.06%. According to
Gutenberg Research
’s Equity Risk Premium Model, the equity risk premium for the company in 2020 is 6.71%.
Cost of Equity = risk-free rate + Beta * (Equity Premium).
= 0.06%+ 2.15 X 6.71%
=0.144865
=14.49%
Tesla’s equity and debt as capital
From Tesla’s balance sheet as at 12/30/2019, the total common stock equity was US$ 6,618,000,000.00 and the total debt was US$ 14,469,000,000.00. Thus, the total value of Tesla is “total liabilities and shareholder’s equity” which is
US$ 6,618,000,000.00 + US$ 14,469,000,000.00
= US$ 21,087,000,000.00
The proportion of debt = total liabilities divided by total value (D/V)
=1446900000/21,087,000,000
=0.68615734812
The proportion of equity = shareholder’s equity divided by total value, or E/V
=6,618,000,000/ 21,087,000,000
=0.31384265187
Calculating an estimate of WACC
The corporate tax rate is 35%, WACC = (E/V)* RE + (D/V)* RD *(1-.35)
= 0.31384265187 x 0.144865 + 0.68615734812 x 5.48% x (1-.35)
=0.045465 + 0.024441
= 0.069906
=6.99%
The corporate tax rate is 25%, WACC = (E/V)* RE + (D/V)* RD *(1-.35)
= 0.31384265187 x 0.144865 + 0.68615734812 x 5.48% x (1-.25)
=0.045465 + 0.028201
= 0.073666
=7.37%
Industrial WACC
According to
Cost of Capital by Sector (US)
, the cost of capital for Auto & Truck was 4.40%. Comparing it to the computed WACC of Tesla using a corporate tax of 35%, Tesla had a WACC of 6.99%. This was higher than the industrial average, meaning that the company is paying its shareholders and investors $0.0699 in return for $1 investment. Generally, both Tesla and the industrial WACC averages were profitable as they were above 3.7%.
References
Cost of Capital. Pages.stern.nyu.edu. (2020). Retrieved 19 December 2020, from
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/wacc.htm
.
Equity Risk Premium Model: Download for free and plug in your own assumptions.. Gutenberg Research. (2020). Retrieved 19 December 2020, from
http://www.gutenbergresearch.com/equity-risk-premium-model.html
.
Fidelity.com. Fixedincome.fidelity.com. (2020). Retrieved 19 December 2020, from
https://fixedincome.fidelity.com/ftgw/fi/filanding
.
Yahoo Finance. Finance.yahoo.com. (2020). Retrieved 19 December 2020, from
https://finance.yahoo.com/quote/TSLA/balance-sheet?p=TSLA
.
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