Introduction
Valuation methods are commonly used by the firms to make decisions. In the current report varied methods of valuation are described in detail. Some methods like cost of debt before and after tax and WACC are applied on the firm data and results are interpreted. At end of the report, methods like DCF, PE ratio and EV/EBITDA are applied on the firm data and results are interpreted.
(A) Methods of estimating cost of capital and limitation of computed figures
Cost of capital refers to the cost of equity and debt (Dhaliwal and et.al., 2011). Methods for computing cost of debt and equity are given below.
Costof debt
There are two approaches that are commonly used for computing cost of debt. One can either compute cost of debt before and after making tax adjustment. Formula for computing cost of debt before tax adjustment is as follows.
|
Kd= Interest/principal*100 |
Table 1 Calculation of cost of debt without considering tax for Easy jet
|
Interest |
11 |
|
Principal |
504 |
|
Cost of debt |
2% |
In this formula only principal amount up to which debt is taken and interest are used to compute cost of debt. Tax is not considered in calculation.
Interpretation and limitation of figures
Cost of debt for Easy jet is only 2% when tax is not taken in to consideration. Main limitation of this figure is that tax amount is not considered in calculation (Li, 2010). It can be observed that in income statement after deducting interest
Opposite to this there is another approach of calculating cost of debt under which after considering tax cost of debt is computed. Formula for same is explained below.
Kd= Principal amount*interest rate*(1-tax rate)
Table 2 Cost of debt without considering tax for Easy jet
|
Principal |
504 |
|
Interest rate |
2% |
|
Tax rate |
20% |
|
Cost of debt |
8.8 |
Interpretation and limitation of figures
After considering tax cost of debt for the business firm is only 8.8%. It can be said that after and before considering tax rate big difference comes in the cost of debt. There is no limitation of figure because in this tax factor is consider to calculate cost of debt.
Cost of equity
Like debt there are two methods that are used to compute cost of equity. These two approaches are dividend yield method and dividend yield plus growth method (Damodaran, 2012). Formula for computing cost of equity by using dividend yield method are given below
|
Ke= DPS/Net proceeds |
Table 3 Cos of equity for Easy jet
|
DPS |
55.2 |
|
Net proceeds |
767 |
|
Ke |
7% |
In this formula only dividend per share and net proceeds that are received per share are taken in to account. Other method that is used to compute cost of equity is earning yield method. Formula of this method is gi
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