Question

Estimate the beta of the company and using the information in its financial statement unlever the beta. Now use the market value information and financial statement information of the company and calculate the levered and unlevered WACC of the company.

What is your recommendation for the company’s capital structure policy?

I am trying to post in table format but it is saying question is too long.

The company is Broadcom and data can be downloaded from yahoo finance.

Link is : https://finance.yahoo.com/quote/AVGO/history?period1=1388534400&period2=1577750400&interval=1mo&filter=history&frequency=1mo

I do not think there is an option for uploading an excel.

Answer 1

]Source for data as per the link provided in question

Beta = 0.81,

Debt = $ 30,011,000 Equity = $ 24,970,000, Debt/ Equity = 1.208,

Tax rate = (Tax Expense / Earning Before Tax )= $ 510,000 / $ 2,226,000 ~ 23%

10 years T-Bond rate (proxy for risk free rate) = 1.566%

Interest Expense = $ 1,444,000

Market Return = 10.33%

Formula for Unlevered Beta = Levered Beta / (1+ {(Debt / Equity) * (1-Tax Rate)})

Unlevered Beta = 0.81 / {1+ (1.208 * (1-23%)} ~ 0.42

Levered Cost of Equity = Risk Free Rate + Levered Beta * ( Market Return - Risk free rate)

Levered Cost of Equity = 1.56 % + 0.81 * (10.33% - 1.56%) ~ 8.67%

Cost of Debt = Interest Expense/ Total Debt

Cost of Debt = $ 1,444,000 / $ 30,011,000 ~ 4.8%

Weight of Debt = (Total Debt) / (Total Equity + Total Equity)

Weight of Debt = $ 30,011,000 /( $ 24,970,000 + $ 30,011,000) ~ 54.6% ~ 0.546

Weight of Equity = (Total Equity) / (Total Equity + Total Equity)

Weight of Debt = $ 24,970,000 /( $ 24,970,000 + $ 30,011,000) ~ 45.4% ~ 0.454

Levered WACC = {Weight of Debt * Cost of Debt * (1- Tax Rate)} + (Weight of Equity * Cost of Equity)

Levered WACC = {0. 546 * 4.8% * (1- 23%)} +(0.454 * 8.67%) ~ 5.96%

Unlevered Cost of Equity = Risk Free Rate + Unlevered Beta * ( Market Return - Risk free rate)

Unlevered Cost of Equity = 1.56 % + 0.42 * (10.33% - 1.56%) ~ 5.24%

Unlevered WACC = {0. 546 * 4.8% * (1- 23%)} +(0.454 * 5.24 %) ~ 4.4%

Recommendation on its Capital Structure: Broadcom is highly levered as its Debt/ Equity is above 1 (computed above). In addition because of levered there cost of capital (WACC) is approximately half of its levered cost of equity.It means Broadcom can raise a money at cheaper rate.

Summary

Levered WACC = ~ 5.96%

Unlevered WACC = ~ 4.4%