QUESTION

PA2 included two parts: Part 1 about evaluating beta and WACC, and Part 2 is about data acquisition in preparation of the CLA2. You need to do both parts to demonstrate your comprehensive evaluation of the company’s opportunity cost as well as your skills in retrieving and organizing historical data on securities for the purpose of portfolio formation.

1. Search Yahoo Finance, or any other credible source to retrieve the most recent income statement and balance sheet for a major leveraged corporation.

a. Provide these statements in proper format and include a screenshot of the data.

b. Retrieve the data on the company’s historical data and calculate annual rate of return by using adjusted closing prices for the past 20 years. using adjusted closing values the past 20 years.

c. Using the data on the company’s stock rate of return and the index’s rate of return estimate beta of the corporation. Compare this value with the value stated by the source.

d. Retrieve the risk-free rate of return as the annual interest rate of US treasuries. Based on these values estimate the expected annual rate of return of the corporation’s security. Compare your estimate with the expected rate of return as evaluated based on your data in part b.

e. Using the financial statements mentioned above estimate the annual rate of interest paid by the corporation (cost of debt). Also, find the tax rate and capitalization ratio (proportions among equity and debt). Using these values that you have found estimate the annual weighted cost of capital (WACC) of the corporation.

2. This part of the assignment is in preparation for CLA2. Choose 5 major securities from different industries, among which one can be the one you chose in part 1 of the question, Retrieve the data on the companies’ historical data and calculate annual rate of return for the past 20 years for each security.

ANSWERS

Professional Assignment 2

Question 1

a. Whirlpool Corporation latest (2019) financial statements

Balance Sheet

Income Statement.

b. Calculate annual rate of return by using adjusted closing prices for the past 20

A stock’s annual rate of return measures how much the stock has been able to increase on average every year over a specified time period (Sim & Wright, 2017). The approach is better while gauging performance as opposed to simple returns as it is often calculated as a geometric average to determine how much an investment has returned over time.

Whirlpool Historical Annual Stock Price Data

Rate of Return Formula = Current Value – Original Value / Original Value * 100

Based on the data, Whirlpool’s Rate of Return will be:

= 142.660904 – 28.739281/28.739281 * 100

= 396.396914%

Annual Rate of return formula = (Current Value/Original Value)1/n – 1

N = 20 years.

Therefore Whirlpool’s Annual rate of return will be as below:

= (142.660904/28.739281)1/20

= 1.083406542 – 1

= 0.083406542 or 8.34065419%

c. Using the data on the company’s stock rate of return and the index’s rate of return estimate beta of the corporation.

Beta measures the volatility or risk of stock as compared to the volatility of the entire stock market. Hollstein, Prokopczuk & Simen (2019) posit that a stock’s beta shows the projected or expected shift in stock price based on the movements in the overall market.

Whirlpool’s Beta will be estimated as follows:

Risk free rate (3 month US Treasury bill) = 0.09%

Whirlpool’s stock rate of return = 8.34065419%

Market rate of return = 10%

Difference between stock rate of return and the risk free rate = 8.34065419 – 0.09

= 8.25065419%

Difference between the market rate of return and the risk free rate = 10-0.09

= 9.91%

Beta Estimate = Difference between stock rate of return and the risk free rate / Difference between the market rate of return and the risk free rate

= 8.25065419/9.91

= 0.832558445

Beta as stated by the source = 1.91 (5Y Monthly)

My Beta is less than one which gives the indication that Whirlpool’s Corporation Stock is generally less volatile than the Market as a whole. The Source gives us a beta of 1.91 which is a 5Y monthly indicating that the stock is quite volatile as compared to the market as a whole.

d. Estimate the expected annual rate of return of the corporation’s security.

Risk free rate = 0.09%

Stock rate of return = 8.34065419%

Market rate of return = 10%

According to Brealey et. al. (2018), Expected Annual Return as from CAPM = RFR+βstock× (Rmarket−RFR)

Where: RFR – Risk free rate

Βstock – Beta of Stock

Rmarket – Market rate of return

Thus Whirlpool Corporation’s Expected Annual Return will be:

=0.09% + 0.832558445 * (10-0.09)

= 0.09% + 8.25065419%

= 8.34065419%

e. Estimate the annual rate of interest paid by the corporation (cost of debt). Also, find the tax rate and capitalization ratio

The cost of debt is essentially the effective rate of interest paid by a firm on its debts. It is represented by a firm’s total debt before making tax deductions (Ghouma, Ben-Nasr & Yan, 2018).

Total Book value of debt from B. Sheet – $5899m

Interest expense from income statement – $187m

Therefore cost of debt = 187/5899

= 0.031700288 or 3.17%

Effective tax rate:

Earnings before income tax – $1552m

Tax Expense – $354m

Thus tax rate = 354/1552

= 0.228092784 or 22.8%

Capitalization ratio:

Whirlpool’s market capitalization (E) is $11586.190m

Book value of Debt (D) – $5899m

Weight of equity = E / (E + D) = 11586.190 / (11586.190 + 5899) = 0.6626

Weight of debt = D / (E + D) = 5899 / (11586.190 + 5899) = 0.3374

Cost of Equity will be Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market – Risk-Free Rate of Return) = 8.34065419 i.e. the Expected Annual rate of return in “d” above.

Whirlpool WACC Calculation will therefore be as below:

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

= 0.6626*8.34065419% + 0.3374*3.17% (1-22.8%)

= 0.063522162

= 6.352%

Whirlpool Corporation has a relatively low WACC implying that is managing its debts and equity well. High WACC figures signals high risks associated with a firm’s operations as it will have to pay more in interest (Budhathoki & Rai, 2020). Theoretically, at 6.352%, Whirlpool must pay its investors an average of $0.0352 for every extra dollar that it acquires.

Question 2

Calculation of annual rates of Return for various securities.

(Calculations are based on the adjusted closing stock prices)

Annual Rate of return formula = (Current Value/Original Value)1/n – 1

1. Whirlpool Corporation

= (142.660904/28.739281)1/20

= 1.083406542 – 1

= 0.083406542 or 8.34065419%

2. Walmart Inc. (WMT)

= (147.934601/ 39.602688)1/20 – 1

= 1.068113133 – 1

= 0.068113133 or 6.811%

3. The Coca-Cola Company (KO)

Annual rate of return:

= (52.779999/ 10.402401)1/20 – 1

= 1.08459298 – 1

= 0.08459298 or 8.459%

4. Apple Inc. (AAPL)

Annual rate of Return

= (122.940002/ 0.334618)1/20 – 1

= 0.343560403 or 34.560%

5. Pfizer Inc. (PFE)

Annual rate of return:

= (37.920025/ 18.946175)1/20 – 1

= 1.035302716 – 1

= 0.035302716

= 3.5303%

Of the five securities analyzed, Apple Inc. has the highest annual rate of return indicating that it is doing well in the market and potential investors can consider investing in it. Research however indicate that high returns often come with high risk and hence investors should be armed with adequate information before making a choice (Wu, Kuehn & Jiang, 2019). Apple’s stock price is however, quite high as compared to the others which are equally attractive. Pfizer Inc. stock, for instance, is quite affordable and has been increasing gradually. With recently released information about Covid vaccine, its stock is bound to rise gradually in the near future.

References

Brealey, R. A., Myers, S. C., Allen, F., & Mohanty, P. (2018). Principles of Corporate Finance, 12/e (Vol. 12). McGraw-Hill Education.

Budhathoki, P. B., & Rai, C. K. (2020). The Impact of the Debt Ratio, Total Assets, and Earning Growth Rate on WACC: Evidence from Nepalese Commercial Banks. Asian Journal of Economics, Business and Accounting, 16-23.

Ghouma, H., Ben-Nasr, H., & Yan, R. (2018). Corporate governance and cost of debt financing: Empirical evidence from Canada. The Quarterly Review of Economics and Finance, 67, 138-148.

Hollstein, F., Prokopczuk, M., & Simen, C. W. (2019). Estimating beta: Forecast adjustments and the impact of stock characteristics for a broad cross-section. Journal of Financial Markets, 44, 91-118.

Sim, T., & Wright, R. H. (2017). Stock valuation using the dividend discount model: An internal rate of return Approach. In Growing Presence of Real Options in Global Financial Markets. Emerald Publishing Limited.

Wu, S., Kuehn, K., & Jiang, J. (2019). A value perspective: The case of warren buffet and his investment behavior towards apple, walmart and amazon. Global Journal of Accounting and Finance, 3(1), 73.