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This assignment explores the calculation and analysis of the cost of capital for AT&T, utilizing financial data sourced from Factset. The analysis includes assessing AT&T's market value, capital structure, cost of equity via the Capital Asset Pricing Model (CAPM), cost of debt, and the company's dividend payout strategies. The purpose is to understand how AT&T finances its operations and the risk and return implications of its capital structure.

Paper For Above instruction

Calculating the cost of capital is fundamental for evaluating a company's investment decisions and overall financial health. For AT&T, the process begins by examining its market valuation; as of January, AT&T's total market value was approximately $258 billion, with its stock trading at $42.01 per share and offering a dividend yield of 4.7%. These figures serve as a basis for estimating the firm's equity cost and understanding its capital structure.

Using the data from Factset, the firm’s total market value of equity (MV(E)) is $258 billion, reflecting its all-common equity capital. To determine AT&T's cost of equity, the Capital Asset Pricing Model (CAPM) is employed. The risk-free rate, derived from the 10-year U.S. Treasury constant maturity bond as of January 25, 2017, was 2.53%. The expected return of the equity market, represented by the S&P 500, was approximately 14.17%, based on the annualized return from 2012-2017. The beta of AT&T, indicating its stock's volatility relative to the market, was noted to be 0.37.

Applying the CAPM formula:

\[ \text{Cost of Equity} = \text{Risk-free rate} + \beta \times (\text{Market return} - \text{Risk-free rate}) \],

we obtain:

\[ 2.53\% + 0.37 \times (14.17\% - 2.53\%) = 6.13\% \],

which aligns with the calculated cost of equity of approximately 6.1%. This relatively low cost reflects AT&T's stable business model and low beta, indicating less sensitivity to market swings.

Turning to its debt, AT&T's total debt as of September 2016 was roughly $125.2 billion. Interest expenses for 2016 were about $4.91 billion. Dividing interest expense by total debt yields a pre-tax cost of debt:

\[ \frac{4.91\text{B}}{125.2\text{B}} \approx 3.92\% \].

Adjusting for taxes, with a tax rate of 32.7%, the after-tax cost of debt becomes:

\[ 3.92\% \times (1 - 0.327) \approx 2.65\%\],

indicating relatively inexpensive debt financing owing to AT&T's creditworthiness and the prevailing low-interest rates.

With the cost of equity and after-tax cost of debt established, the Weighted Average Cost of Capital (WACC) — which measures the average rate of return required by investors — can be calculated. Assuming a capital structure with total equity of $258 billion and debt of $125.2 billion, the leverage ratio and respective weights are computed. The proportion of debt in the capital structure is approximately 48.7%, with equity constituting the remaining 51.3%. The WACC is then calculated as:

\[ \text{WACC} = \frac{E}{E + D} \times \text{Cost of Equity} + \frac{D}{E + D} \times \text{Cost of Debt} \times (1 - \text{Tax Rate}) \],

which simplifies to:

\[ 0.513 \times 6.1\% + 0.487 \times 2.65\% \approx 4.97\% \].

This modest WACC indicates AT&T's capacity to undertake investments at relatively low costs, supporting strategic growth initiatives.

Dividend policy analysis reveals AT&T's dividend payments for 2015 and 2016 were $1.89 and $1.93 per share respectively, demonstrating stable and increasing dividends. The payout ratios, derived from dividing dividends per share by earnings per share (EPS), highlight investor expectations and company profitability. With a payout ratio around 91.9% in 2016, AT&T distributes a significant portion of its earnings, which aligns with its commitment to shareholder returns.

The company's leverage ratio, calculated as total debt divided by total equity, was identified as over 100% in December 2016, emphasizing a heavily leveraged position. While increased leverage can amplify returns during growth periods, it also introduces financial risk, especially if earnings decline.

In conclusion, AT&T exhibits a robust capital structure characterized by low-cost debt, moderate equity risk, and a high dividend payout ratio. Its low WACC suggests favorable financing conditions, enabling the company to pursue strategic investments. The stable and predictable cash flow pattern underpins its dividend policy, reaffirming investor confidence. These insights highlight how AT&T effectively manages its capital to balance growth, risk, and shareholder value.

References

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