Corporate Finance -WACC - Reasons For Qantas - Assessment Answer

Corporate Finance Assignment

Assignment Task

WACC = E/(E + D)*Cost of Equity+D/(E + D)*Cost of Debt* (1 - Tax Rate)

Where E = market value of equity also known as market capitalization of Qantas. Market Cap.= 5.56b

D= book value of debt which is the average of two years value of debt.

Long term debt value = (4421+4791)/2 = 4606 million

Short term debt value = (441+771)/2 = 606 million

Total debt value (D) = 4606+ 606 = 5212 million = 5.212bn

Weight of equity = E/(E+D)= 5.56/(5.56+5.212) = 5.56/ 10.772 = 0.5165

Weight of Debt = D/(E+D) = 5.212/10.772 = .483

Cost of equity:

Using the CAPM model, cost of equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market - Risk-Free Rate of Return)

Risk free rate of return = 2.48

Beta of Qantas = 1.07

Market premium = 7.5%

Cost of equity = 2.48+1.07(7.5) = 10.505

Cost of debt = interest expenses / average total debt

= .227/5.212 = 4.355%

Average tax rate = 28.38%

WACC = (0.5165* 10.505)+.483*4.355%* (1-.2838)

= 5.426+ 2.103(.7162) = 6.932%

Buy back of shares implies that the firm is cash intensive and is enjoying a position of profitability. However this cash has opportunity cost involved in it. The same cash could have been invested in other avenue and returns be increased. The firm Qantas announced a buyback of its shares worth $500 million. The rationale behind the buyback generally is to enhance its control and ownership. However, buybacks also prove a firm’s investment in own shares signaling their confidence in the company’s future. Qantas has revived in the past two years from a net loss to a net profit figure. Thus the buyback of shares show the company’s firm belief in its own future. The buyback of shares also aims at providing benefits to existing shareholders by utilizing the unneeded cash in buyback. The potential buyback of Qantas was primarily focused on sending positive signals on company’s future. At the same time Qantas might have thought to a more even distribution of capital and thus preferred the buyback. Buyback of shares also sends a strong signal to those who were aiming for hostile takeovers, as Qantas was facing losses in the past.