This paper analyzes FedEx Corporation's cost of capital in the context of potential international expansion. It examines the company's capital structure, comparing the trade-offs between debt and equity financing for new market entry. Using the Capital Asset Pricing Model (CAPM), the paper calculates FedEx's cost of equity and then derives the weighted average cost of capital (WACC) based on the firm's 2014 capital structure. The analysis also considers macroeconomic and operational factors — including GDP, labor costs, fleet expenses, and competitive conditions — that FedEx should weigh when evaluating foreign markets, concluding with observations about the firm's share buyback strategy and its effect on future capital costs.
FedEx Corporation offers worldwide delivery services in the overnight and ground shipping businesses, along with other related logistics services. The company operates around the world, utilizing either wholly-owned subsidiaries or service partners to gain market entry. If the company is considering making an investment in a foreign country, it can begin by determining the cost of capital. Most of the company's business is in the United States, so the domestic cost of capital is the applicable benchmark.
There are different methods of financing that could be used to fund an international expansion — debt or equity. Debt financing has the benefit of a lower cost, but it also increases the risk the company faces. Equity financing carries a higher cost but less risk, since fewer of the company's cash flows are directed toward debt service. Moreover, if the company wants to match the term of the financing with the term of the project, a new market entry for FedEx represents an effectively infinite time horizon and will therefore align better with equity financing.
In considering where to expand, FedEx needs to examine a number of market factors. The first is potential demand. Macroeconomic variables such as GDP or GDP per capita are good indicators of suitable markets, since countries that are too poor will have little demand for FedEx's premium shipping services. In some lower-income countries, however, certain cities possess enough wealth to sustain the company's operations, so FedEx maintains a limited presence in select markets, servicing only areas with strong earning potential.
The company must also consider the costs of entering a market, which would naturally be weighed against the expected benefits. There are two major cost factors for FedEx. The first is salaries and wages, which are high in developed countries but somewhat lower in many of the markets that remain untapped. The company's other major expense comes from its fleet — aircraft, vehicles, and fuel. These costs are relatively constant around the world, though fuel price differentials exist in some countries. Revenue will be affected by local market conditions, particularly competitive benchmarking.
The Capital Asset Pricing Model (CAPM) is used to calculate the cost of equity. The risk-free rate is 0.117%, based on the 1-year U.S. Treasury yield (Yahoo Finance). The market risk premium is assumed to be 7%. The beta for FedEx is 1.50. Applying the CAPM formula yields the following cost of equity:
Cost of Equity = 0.117 + (1.5)(7) = 10.62%
The weighted average cost of capital (WACC) is calculated by incorporating both the cost of debt and the cost of equity, weighted according to the firm's capital structure. The capital structure of FedEx is 47.7% debt and 52.3% equity as of Q2 FY2014 (MSN Moneycentral, 2014). FedEx had recently completed a bond issue with a yield of 4% on 10-year notes (Robinson, 2014). The WACC tells us the overall cost of capital for FedEx given these inputs:
WACC = (0.477)(4) + (0.523)(10.62) = 1.908 + 5.554 = 7.46%
"WACC formula applied to FedEx capital structure"
"Share buybacks and declining future WACC outlook"
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