Management Accounting Sample
Task 1: Calculation of the Weighted Average Cost of Capital
Weighted Average Cost of Capital is financial term that is a kind of calculation of a firm’s cost of capital. In this process, each category of the capital such as debt and equity is weighted. In order to calculate the weighted average cost of capital, below formula is used:
WACC = E / (E + D) * Re + D / (E + D) * RD* (1 – Tax Rate) (Lasher, 2010)
Re refers to cost of equity
Rd refers to cost of debt
E refers to market value of the firm’s equity
D refers to market value of the firm’s debt
V = E + D = total of equity and debt
E/V = Weight of equity
D/V = weight of debt
Tax Rate = corporate tax rate
In the reference of Woolworth, WCC is below
Weight of cost and equity
Total debt = 14,720.30 million
Total equity = 8,781.90 million
Weight of debt = 14,720.30/ (14,720.30+ 8781.90) = 62.63%
Weight of equity = 8781.90 / 14,720.30+ 8781.90) = 37.37%
Cost of Equity
In order to compute cost of equity, capital assets pricing model (CAPM) will be used. The formula of CAPM is following:
Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market – Risk-Free Rate of Return) (Graham and Smart, 2011)
Risk-Free Rate of Return = 2.41
Beta of Asset = 0.89
Expected Return of the Market – Risk-Free Rate of Return = It is also known as the market premium that 6%
Cost of equity = 2.41000000% + 0.89 * 6%
Cost of debt
According to financial year information 2016, Woolworth paid 181.79 million as the interest on the debt of 3437.01. Hence, the cost of debt is below calculated:
= 181.79 / 3437.01
Tax rate = 34.27%
After the collection of all the significant information, the calculation of WACC is below:
WACC = E / (E + D) * Re + D / (E + D) * RD* (1 – Tax Rate)
= 0.37 * 7.75% + 0.63* 5.2892% * (1 – 34.27%)
The above calculation of the WACC depicts that the analyst is sued below formula:
WACC = E / (E + D) * Re + D / (E + D) * RD* (1 – Tax Rate)
This formula is most of time used to calculate the WACC because it is reliable method. In the calculation, it can be seen that both categories of the capital such as debt and equity changed according the weight in the capital.
Further, cost of the debt is calculated on the basis of interest paid during the financial year. In order to calculated cost of equity, capital assets pricing method is used that is effective provide accurate result (Field, 2012). In the reference of tax rate, it is found that the rate of the corporate tax is 34.27%.
Gearing ratio is an important part of the financial that depicts the firm’s long term debt compared to its equity capital. In order to calculate the gearing ratio, the below formula is used:
Gearing Ratio = Long term liabilities / Capital Employed * 100 (Edmonds, et. al. 2015)
|Gearing Ratio Woolworth||2014||2015||2016|
|Long term liabilities||13,679.80||14,204.80||14,720.30|
In order to calculate to gearing ratio, the analyst did not get any major difficulty. But, to search the financial data of the company, the analyst had to go different sources because each year’s financial information was available on the different annual report.
|Ratio calculation Woolworth||2014||2015||2016|
|Capital structure ratio|
|Debt to equity ratio|
|Debt ratio (to assets)|
|Interest coverage ratio|
|Net finance cost (Used net interest expense)||277.8||253.3||245.6|
|Debt coverage ratio|
|Non Current liabilities||6,121.60||5,036.20||5,727.60|
|Net cash flow from operating activities||3,472.70||3,345.10||2,357.50|
While studying of current capital structure, it is found that Woolworth is having 1.68 of debt in comparison to equity which is challenging and threat for the company and its investors. In respect of this, it can be recommended to Woolworth Company that company should focus on reducing its debt and increase its equity so that threat can be overcome.
For this, Woolworth must re-design its capital structure in order to issue stock to gain the more capitals as the equity. However, it is very much clear that debt to equity need to be equal to each other so that business and its operational activities can be managed and operate smoothly and efficiently (Pingle, 2013).
In the same concern of this, company need to increase equity for the company so that shareholders feel creditor regarding their interest i.e., return on investment. The increase in equity will provide the benefit to the organization in form of interest expenses which will reduce the taxable income to some extent.
In addition, increase in equity will affect the Woolworth in positive manner in terms of return on assets and return on equity (Harris, 2014). At the same, it also recommended to the company that they must conduct a proper research in order to select the capital structure as well as measure profitability ratio in respect of some issues which company can face.
Therefore, adopting both recommendations will help the company to achieve the organizational goals and also help in developing a positive relationship with the company’s shareholders by giving return on equity on time (McIntosh, et. al. 2010).
Edmonds, T., Nair, F., Olds, P. and Edmonds, C. (2015) Fundamental Financial Accounting Concepts. USA: McGraw-Hill Higher Education.
Field, R. (2012) Planning and Budgeting Skills for Health and Social Work Managers. UK: Sage.
Graham, J. and Smart, S. (2011) Introduction to Corporate Finance: What Companies Do. 3rd edn. USA: Cengage Learning.
Harris, C. (2014) Fixed and Variable Costs: Theory and Practice in Electricity. USA: Palgrave Macmillan.
Lasher, W. R. (2010) Practical Financial Management. USA: Cengage Learning.
McIntosh, E., Clarke, P. & Frew, E. (2010) Applied Methods of Cost-Benefit Analysis in Health Care. USA: OUP Oxford.
Pingle, M. (2013) BASIC ACCOUNTING CONCEPTS: A Beginner’s Guide to Understanding Accounting. USA: Xlibris Corporation.