1 Mini-Project 3: Weighted Average Cost of Capital (80 points): 2 Find 2016 fina

Question

1 Mini-Project 3: Weighted Average Cost of Capital (80 points): 2 Find 2016 financial statements for Amazon.Com from UHV Mergent Online database, Yahool Finance, Google Finance, or other finance sources. 3 (1) Estimate the weights of capital (debt, preferred stock, and common stock) for the company. 4 (2) Estimate the before-tax and after-tax component cost of debt for the firm 5 (3) Estimate the component cost of preferred stock (if applicable) for the firm. 6 (4) Estimate the component cost of common equity using CAPM for the firm. 7(5) Compute the firm's weighted average cost of capital (WACC). Discuss your findings.

Explanation / Answer

If you refer balance sheet of Amazon com for the financial year 2016, you will note the following things:

Long term debt - $7,694Million, total stake holder equity- $19,285 Million which is all on account of common stock as there is no preferred stock share which is issued and outstanding

Weights of capital can thus be easily calculated by dividing amount of particular capital / total capital

Therefore, weight of long term debt = $7694/ ($7694+$19285)= $7694/$26979= 28.5%

and total weight of common stock= $ 19285/$26979= 71.5%

this is the answer to first question

For second question, please note interest expense from Profit and loss statement i.e. $ 484 million , therefore before tax component of cost of debt = $484/$7694 i.e. nothing but interest expense/ total long term debt =6.29%

As we know that interest is tax deductible, therefore these interest payments will be exempt from tax . Hence, after tax cost of debt is (1-tax rate)* debt cost

Now to find out tax rate we know, tax provision done by company in 2016 = $1425 million against income before tax of $3892 million, therefore percentage of tax = $1425/$ 3892= 36.61%

So, after tax cost of debt = (1-36.61%)* 6.29%= 3.99%

This is answer to question 2

There is no preferred stock for the firm , therefore zero cost on that account

We know CAPM model states that cost of common equity= risk free return + beta* Market risk premium

Equity market risk premium is close to 6% for US equity

and risk free rate is 5%, beta for amazon stock is 1.39

Substituting these values , you will get cost of common equity= risk free rate+ beta * Market risk premium

= 5%+1.39* 6%= 13.34%

These values will change if you tend to change any of beta, risk free rate and market risk premium value

Please post remaining questions separately

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