Managerial finance principles and applications

Managerial Finance

As of the latest 10-K, for the year ended February 1, 2008, the book value of Dell's liabilities was $23,732 (million). The book value of Dell's equity was $3,735. The book value of the long-term debt was $362 million. At the time, long-term debt consisted of $200 million that was due in April, 2008 and was thus not included in the $362 million figure but rather as a current liability. The company was planning to replace this with a new debt issue. The long-term debt also had a $300 7.1% fixed rate senior debenture due in April 2028.

According to the latest 10-Q, for the quarter ended October 31, 2008, the book value of Dell's liabilities was $23,658 million. The book value of Dell's equity was $4,149 million. The book value of long-term debt was $1,851 million. This includes the 2028 debentures noted above and three new issues. These are $600 million at 4.7% due 2013; $500 million at 5.65% due 2018 and $400 million at 6.5% due 2038.

As of market close on December 26, 2008, the most recent trade of Dell stock was at $10.65. There are 1.944 billion shares outstanding. The market cap for Dell is $20.71 billion. The beta is 1.43. The 3-month T-Bill yield is 0.01%. Therefore, the cost of Dell's equity using CAPM is:

Re = Rf + B (Rm) =.01 + 1.43 (7.01) = 10.03%

3) Reuters calculates the industry average beta as 0.98. They also provide a list of major competitors, which includes Apple, IBM and Hewlett-Packard. Those companies have betas of 2.09, 1.10 and 1.05 respectively. Using those three betas plus Dell's to calculate an average industry beta, we arrive at 1.4175. Using CAPM, this gives us a cost of equity of 01 + 1.4175 (7.01) = 9.94%.

In this case, it does not matter much if the beta for Dell is used or the beta for the industry. The numbers are fairly similar. Given that the exercise has the ultimate goal of estimating the cost of capital for GCI, however, it is reasonable that the beta for the industry is used. The characteristics of GCI and Dell are not the same; therefore the industry risk is every bit as reasonable at Dell's risk, which incorporates firm-specific volatility that may not apply to GCI.

4) the YTM on Dell's bonds are as follows. The 2013 bonds are 5.505%; the 2018 are 6.637%; the 2028 are 8.317% and the 2038 are 8.092%. Using the book value weights, the weighted-average cost of debt is 6.854%. The weights are 33.33% on the 2013s; 27.78% on the 2018s 16.67% on the 2028s and 22.2% on the 2038s.

Using market value the weighted-average cost of debt is 6.798%. The weights are 35.42% on the 2013s; 28.39% on the 2018s; 16.14% on the 2028s and 20.03% on the 2038s. Thus, it does make a difference if book or market value weights are used. In this case, the market value weights skew more towards the short maturities, which have the lowest yields. This gives the weighted-average cost of debt for market value weights a slightly lower figure.

5) by book value, the weight for debt is 30.85% and equity 69.45%. This gives a weighted average cost of capital of:

We (Re) + Wd (Rd) (1 - T) =.6945(9.94) + (.3085)(6.854)(.65) = 8.277%

By market value, the weight for debt is 7.345% and the weight for equity is 92.645%. This gives a weighted average cost of capital of:

9265(9.94) + (.0735)(6.798)(.65) = 9.534%

The cost of capital that is more relevant is the book value. The market value takes into account market perceptions of future growth, where only past performance and existing intrinsic value are included in book value. When calculating cost of capital, it is best to omit any speculation about how the market will perceive the firm's growth potential.