You Are The Genesis Accountant And Have Taken A Recent Class

You Are The Genesis Accountant And Have Taken A Class Recently In Fina

You are the Genesis accountant and have recently taken a class in financing. Prepare a 10–12 slide PowerPoint presentation that covers the following topics:

  • Calculating the expected interest rate (cost of debt) for Jones Industries, which borrows $600,000 for 10 years with an annual payment of $100,000.
  • Determining the expected rate of return (cost of equity) for Jones Industries’ stock, given its beta of 1.39, the risk-free rate of 3%, and the expected market return of 12%.
  • Analyzing the company's financial position using the provided asset and liability figures, including total assets of $2,000,000, debt of $600,000, internal stock equity of $400,000, and new stock equity of $1,000,000.

Include calculations performed in Excel, with copied and pasted figures, and add speaker’s notes to explain each point thoroughly. Use APA standards for citing sources and save the presentation with the filename format: LastnameFirstInitial_M4_A2.ppt.

Paper For Above instruction

The financial analysis of Jones Industries' debt and equity components is essential for understanding its cost of capital and overall financial health. This paper provides detailed calculations of the company's cost of debt and cost of equity, along with an analysis of its financial position, supported by appropriate financial theories and formulas.

Introduction

In contemporary corporate finance, determining a company's cost of debt and equity is fundamental for capital budgeting and financial decision-making. Debt financing, often cheaper than equity, influences a company's leverage and financial risk. Conversely, the risk associated with equity investment depends on market dynamics and company-specific factors. This analysis covers calculating both costs for Jones Industries, supplemented by the company's financial overview.

Cost of Debt Calculation

Jones Industries has borrowed $600,000 over ten years, with an annual payment of $100,000. To calculate the company's effective interest rate, the loan's amortization schedule is analyzed. Utilizing Excel, the internal rate of return (IRR) function provides the approximate annual interest rate or cost of debt.

Using Excel functions, the cash flows are structured as follows:

  • Initial loan: -$600,000 at year 0
  • Annual payments: +$100,000 for years 1 through 10

Applying the IRR function to these cash flows yields an approximate annual interest rate of 7%. This is interpreted as the company's cost of debt since it reflects the explicit interest cost on the borrowed funds.

Furthermore, adjustments can be made for tax implications because interest expenses are tax-deductible, lowering the effective cost. Assuming a corporate tax rate of 21%, the after-tax cost of debt is calculated as:

After-tax cost of debt = 7% × (1 - 0.21) ≈ 5.53%

Cost of Equity Calculation

The Capital Asset Pricing Model (CAPM) is employed to determine Jones' cost of equity, which considers the risk-free rate, the stock's beta, and market risk premium.

The CAPM formula is:

Cost of Equity = Risk-Free Rate + Beta × Market Risk Premium

Plugging in the values:

  • Risk-Free Rate = 3%
  • Beta = 1.39
  • Market Return = 12% → Market Risk Premium = 12% - 3% = 9%

Therefore:

Cost of Equity = 3% + 1.39 × 9% = 3% + 12.51% = 15.51%

Financial Position Analysis

Jones Industries' balance sheet figures indicate a total asset base of $2,000,000, with total liabilities and equity matching this amount. The company's structure is as follows:

  • Long- and short-term debt: $600,000
  • Internal common stock equity: $400,000
  • New common stock equity issued: $1,000,000

This capital structure reveals a mix of debt and equity financing. The debt-to-equity ratio is:

Debt-to-Equity Ratio = Total Debt / Total Equity = $600,000 / ($400,000 + $1,000,000) = 600,000 / 1,400,000 ≈ 0.43

This indicates moderate leverage, which impacts the company's weighted average cost of capital (WACC). The WACC calculation involves weighting the costs of debt and equity according to their proportion in the capital structure.

Conclusion

This financial analysis demonstrates that Jones Industries' cost of debt, after tax, is approximately 5.53%, and its cost of equity is estimated at 15.51%. The capital structure, characterized by a debt-to-equity ratio of 0.43, suggests a balanced leverage profile. These metrics are essential for strategic decision-making, investment appraisal, and risk management. Future assessments should consider market conditions and the company's operational risk to refine these estimates further.

References

  • Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education.
  • Damodaran, A. (2015). Applied Corporate Finance. Wiley Finance.
  • Ross, S. A., Westerfield, R., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
  • Fama, E. F., & French, K. R. (1992). The Cross-Section of Expected Stock Returns. The Journal of Finance, 47(2), 427–465. https://doi.org/10.2307/2329112
  • Sharpe, W. F. (1964). Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk. The Journal of Finance, 19(3), 425–442. https://doi.org/10.2307/2977928
  • Investopedia. (2023). Cost of Debt. https://www.investopedia.com/terms/c/costofdebt.asp
  • Investopedia. (2023). Cost of Equity. https://www.investopedia.com/terms/c/costofequity.asp
  • U.S. Department of the Treasury. (2023). Daily Treasury Yield Curve Rates. https://home.treasury.gov/policy-issues/financing-the-government/interest-rate-statistics
  • Brigham, E. F., & Houston, J. F. (2019). (15th ed.). Cengage Learning.
  • Wikipedia contributors. (2023). Weighted Average Cost of Capital. In Wikipedia, The Free Encyclopedia. https://en.wikipedia.org/wiki/Weighted_average_cost_of_capital

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