This paper has three parts. The first two parts cover questions about portfolio theory, especially diversification, using a hypothetical 401(K) plan as the prompt. The second question is about calculating the WACC, using Dell as the example, and then discussing the appropriateness of different techniques used in the analysis of the issue.
Corporate Finance
East Coast Yachts I
My time horizon is long-run. I would want a diversified portfolio, but can afford to take the risk of equities. So the first decision is to go with 100% equities. I am not interested in company stock at the moment, because I want a diversified portfolio and I only want liquid securities with values set by the market. The company stock does not meet those criteria.
In that case, I would emphasize the Small Cap fund for its growth characteristics -- 50%, and a further 50% in the S&P index fund. The Index Fund has a substantially lower MER than the Large Company fund. The Large Cap has outperformed the market lately, but cannot be expected to do that every year, and it has a lower Sharpe ratio so is a riskier fund that the S&P -- it should outperform. On a risk-adjusted basis, net of the MER, I feel that the Index Fund is a better investment than the Large Cap. Thus 50% in Index Fund, 50% in Small Cap.
East Coast Yachts II
Sarah should point out a few things about investing entirely in the stock. The first is that a portfolio should have a higher degree of diversification to insulate against adverse performance of a single asset. If anything were to happen to East Coast Yachts, the retirement fund could be wiped out, something that would not happen if I had a more diversified portfolio.
Indeed, since my income is tied to this company today, it makes no sense for my retirement to also be tied to the fortunes of the same company, if I am not the CEO and calling the shots. Sarah should point out that the retirement fund should insulate me from adverse conditions at any one company, and should therefore be diversified to achieve that goal. She should offer one or more funds as a means of supplementing the company stock, so that the portfolio has a high level of diversification.
Goff Computer
1. The capital structure of Dell (as of December 2009) is 83.9% debt and 16.1% equity.
2. Dell's beta is 1.41. The risk-free rate is 0.15% for a 1 year treasury. The company's bonds are at -0.754% for the 2014s ($400m), 0.431% for the 2015s ($700m), 2.631% for the 2019s ($600m), 3% YTM for the 2021 maturities ($400m) and 4.769% for the 2028 maturities ($400m) and 4.908% for the 2040 maturities ($300m). The cost of equity for Dell therefore is 10.02%. The latest stock price for Dell is $14.32, which gives it a market cap of $24.9 billion. There are 1.74 billion shares outstanding.
3. Today, HPQ has a beta of 1.13; Hitachi has a beta of 1.27; EMC has a beta of 1.02; Corning has a beta of 1.44 and Western Digital has a beta of 1.47. The industry average beta would be
1.27. Thus, using this figure instead of Dell's figure, the cost of equity would be 8.74%.
4. For debt, Dell has total debt of $2.8 billion. Thus, the weighted-average yield to maturity is 2.2%:
Maturity
Weight
Yield
2014
0.142857
-0.754
-0.10771
2015
0.25
0.431
0.10775
2019
0.214286
2.631
0.563786
2021
0.142857
3
0.428571
2028
0.142857
4.769
0.681286
2040
0.107143
4.908
0.525857
2.199536
In this case, book value weights are used. Market value weights would be redundant, since market value incorporates the price and yield to maturity also incorporates market price. Also, book value is more relevant because the market price of the stock is speculative, whereas the book value of equity is based on actual earnings that have happened. There is no anticipatory factor -- the retained earnings are the bulk of the book value.
5. The weighted-average cost of capital for Dell is:
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