Posted on April 26th, 2014, by essay
Investment decisions should be done basing on the analysis of industry and company data. In particular, decisions regarding investment projects with predictable cash flows are evaluated using the company’s cost of capital, duration of the project and other parameters. With the help of such techniques as NPV, IRR and payback period, feasibility of the project’s can be estimated and management can decide whether the project corresponds to the chosen financial strategy and its limitations. The purpose of this paper is to determine the cost of capital for FedEx Corporation, using industry and company data (part 1), and to determine NPV of the proposed investment project using the precalculated cost of capital (part 2).
Estimation of the company’s weighted average cost of capital
For evaluating investment projects, the figure which is most frequently chosen as capital cost, is weighted average cost of capital (WACC), which is defined by the following formula: , where E is the market value of the company’s equity, D is the market value of the company’s debt, R_{e} denotes cost of equity, R_{d} denotes cost of debt, and T_{c} is the effective corporate tax rate (Brigham & Daves, 2009).
Thus, in order to determine weighted average cost of capital for FedEx Corporation, it is necessary to determine book and market value of equity and debt financing for the company, to determine the proportion of debt and equity financing according to the market estimates of debt and equity financing. The cost of debt can be determined using shortterm interest rates applicable to FedEx Corporation, longterm debt interest rates and corporate tax rate. The cost of equity can be determined using CAPM equation: , where Rm is expected market return, Rf is riskfree rate of return, the difference RmRf is referred to as the market premium, and beta is the coefficient measuring the stock’s volatility with regard to market volatility (Brigham & Daves, 2009).
Table 1 shows the prerequisites for calculating the WACC for FedEx Corporation.
Source of Finance  
Balance sheet value as of:  (in millions, except proportion) 
1.1. Debt 
$11,091 
1.2. Equity 
$13,811 
Market value as of:  
2.1. Debt 
$11,210 
2.2. Equity 
$27,265 
Proportion  
debt 
29% 
equity 
71% 
Table 1. Book and market values of debt and equity for FedEx Corporation
Book values of debt and equity were exported from FedEx 2010 report, and market values were calculated in the following way. Market value of debt was determined using supplementary information in Table 2 showing the details of longterm debts of FedEx Corporation.
Senior unsecured debt  (millions) 
Interest rate of 5.50%, due in 2010  – 
Interest rate of 7.25%, due in 2011 
$250 
Interest rate of 9.65%, due in 2013 
$300 
Interest rate of 7.38%, due in 2014 
$250 
Interest rate of 8.00%, due in 2019 
$750 
Interest rate of 7.60%, due in 2098 
$239 
Table 2. Details of longterm debt for FedEx Corporation (FedEx Corporation, 2012)
Market value of debt was reestimated using the interest rate of 7.25% actual for the current portion of debt payable in 2011. Book value of longterm debt was $1,668m, and market value of longterm debt was $1,787m. Book value of other longterm liabilities is supposed to be similar to market value, since appropriate recalculations are listed in FedEx 2010 report (FedEx Corporation, 2012). Thus, market value of debt for FedEx Corporation is estimated as $11,210m.
Market value of equity was calculated as the number of shares outstanding ($314m) multiplied by market value of FedEx stock ($86.83, as to July 6, 2012) (FedEx Corporation, 2012). Estimated market value of FedEx equity is $27,265m. Thus, according to market values of debt and equity, FedEx Corporation uses 29% of debt financing and 71% of equity financing.
For FedEx Corporation, beta equals to 1.55, and riskfree rate which is equal to oneyear Tbill return is 0.18%. Market premium is supposed to be 6%, so the cost of equity for FedEx is:
The cost of debt will be calculated in the following way. Shortterm interest rate is 0.25%, and longterm interest rate can be determined as the average interest rate for longterm loans basing on the data of Table 2. The cost of longterm debt for FedEx is estimated as 8.03%. The value of shortterm debt is $4,645m, and the value of longterm liabilities is $6,446m; thus, averaged value of the cost of debt is 4.77%. Effective tax rate in 2010 for FedEx was equal to 37.50% (FedEx Corporation, 2012).
Using the data calculated above, it is now possible to determine WACC:
Capital budgeting decision for FedEx
The data for the supposed investment project are listed in Table 3. Supplies, labor and marketing expenses and revenues are expressed in Canadian dollars, investments in machinery and equipment are expressed in US dollars.
Year 
Investment in Machinery and equipment 
Purchase of office supplies 
Direct and indirect labor 
Marketing expenses 
Revenues 
0 
8,000(1) 
0 
0 
400 
0 
1 
8,000(2) 
20 
4,800 
800 
8,000 
2 
4,000(3) 
10 
5,600 
690 
13,000 
3 
0 
10 
5,600 
690 
13,000 
4 
0 
10 
5,600 
690 
13,000 
5 
0 
10 
5,600 
690 
13,000 
6 
0 
10 
5,600 
690 
13,000 
Equipment 1 = $8,000(1) 
Equipment 2 = $8,000(2) 
Equipment 3 = $4,000(3) 
Table 3. Costs and revenues of new investment project
First of all, it is necessary to convert the data for project costs and revenues to US dollars instead of Canadian dollars. For this, interest rate parity equation will be used: (Brigham & Daves, 2009), where is the expected exchange rate, is the current exchange rate (1 CAD = S_{0} USD), RL_{T} is the yield to maturity of U.S. government bonds maturing in T years, and RFOREIGN_{T} is the yield to maturity of Canadian government bonds. These supplementary values are listed in Table 4.
YTM  US  Canada  S_{0}  EST 
1 
0.17% 
0.99% 
0.976963 
0.969030436 
2 
0.26% 
0.99% 
(USD per 1 canadian $) 
0.969901083 
3 
0.36% 
1.07% 
0.970099997 

4 
0.53% 
1.18% 
0.9706868 

5 
0.69% 
1.25% 
0.97155955 

6 
0.88% 
1.36% 
0.972336498 
Table 4. YTM of US and Canadian government bonds (Bloomberg.com, 2012), exchange rate of CAD and USD (xrates.com, 2012), and EST calculation
Using EST exchange rate estimates, all investment estimates for the project were converted into US dollars. Depreciation values were calculated using salvage value of all three investments and 4year direct depreciation for each investment. Table 5 shows the results of conversion, calculation of pretax revenue, tax values provided that effective tax rate fro FedEx Corporation is 37.5%, and the value of aftertax income.
Year  Investment in Machinery and equipment (USD thousands)  Purchase of office supplies (USD thousands)  Direct and indirect labor (USD thousands)  Marketing expenses (USD thousand)  Revenues (USD thousands)  Depre–ciation  Pretax revenue less depreciation  Tax  Aftertax income 
0 
$8,000.00 
$0.00 
$0.00 
$390.79 
$0.00 
$0.00 
($390.79) 
$0.00 
($390.79) 
1 
$8,000.00 
$19.38 
$4,651.35 
$775.22 
$7,752.24 
$1,250.00 
$1,056.29 
$396.11 
$660.18 
2 
$4,000.00 
$9.70 
$5,431.45 
$669.23 
$12,608.71 
$2,500.00 
$3,998.34 
$1,499.38 
$2,498.96 
3 
$0.00 
$9.70 
$5,432.56 
$669.37 
$12,611.30 
$3,250.00 
$3,249.67 
$1,218.63 
$2,031.04 
4 
$0.00 
$9.71 
$5,435.85 
$669.77 
$12,618.93 
$3,250.00 
$3,253.60 
$1,220.10 
$2,033.50 
5 
$0.00 
$9.72 
$5,440.73 
$670.38 
$12,630.27 
$2,000.00 
$4,509.45 
$1,691.04 
$2,818.41 
6 
$0.00 
$9.72 
$5,445.08 
$670.91 
$12,640.37 
$750.00 
$5,764.65 
$2,161.75 
$3,602.91 
Table 5. Calculations of pretax and aftertax income
Using the aftertax value of revenue, free cash flows (FCF) were calculated as the sum of aftertax income plus depreciation plus salvage value of M&E in the end of year 6, and less the values of investments during years 02. Estimates of present values for resulting cash flows were done using the 8.11% cost of capital for FedEx corporation obtained in Part 1. Present value of every cash flow was calculated in the following way: , where CF_{i} is the cash flow for year i, and r is the cost of capital (). NPV is determined as the sum of present values of all cash flows. Supplementary values used for calculating NPV and NPV value are shown in Table 6.
Year 
FCF 
Cost of capital (r) 
Factor (1+r)^i 
PV(CF) 
0 
($8,390.79) 
8.11% 
1.00 
($8,390.79) 
1 
($6,089.82) 
1.08 
($5,632.98) 

2 
$998.96 
1.17 
$854.71 

3 
$5,281.04 
1.26 
$4,179.48 

4 
$5,283.50 
1.37 
$3,867.75 

5 
$4,818.41 
1.48 
$3,262.68 

6 
$11,352.91 
1.60 
$7,110.69 

NPV 
$5,251.54 
Table 6. NPV calculation for the project
Since NPV value is greater than zero, the project can be evaluated as profitable. Moreover, the value of NPV is significantly above zero, which means that the project will yield revenues, and will have certain protection against risks (a cushion pad against losses and unexpected situations).
Conclusion
The cost of capital for FedEx Corporation, estimated using WACC model and CAPM model, was equal to 8.11% in 20102011 year. Using this cost of capital, the proposed investment project was analyzed, using NPV method. NPV equal to $5,251,540 shows that the project is profitable and should be accepted by FedEx Corporation as a perspective investment.
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