Proessay.com

Research paper on Research of FedEx Corporation diversification project

Introduction

Investment decisions should be done basing on the analysis of industry and company data. The purpose of this paper is to determine the cost of capital for FedEx Corporation, using industry and company data, evaluate investment decision basing on the supposed project cash flows, and consider important economic and financial variables which might affect the development of this investment project in Canada.

1. 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). 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 short-term interest rates applicable to FedEx Corporation, long-term debt interest rates and corporate tax rate. The cost of equity can be determined using CAPM equation (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

For FedEx Corporation, beta equals to 1.55, and risk-free rate which is equal to one-year T-bill 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. Short-term interest rate is 0.25%, and long-term interest rate can be determined as the average interest rate for long-term loans basing on the data of Table 2. The cost of long-term debt for FedEx is estimated as 8.03%. The value of short-term debt is $4,645m, and the value of long-term 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:

 

2. Capital budgeting decision for FedEx

Using the project’s initial data on cash flows in Canadian currency, and EST exchange rate estimates, the forecasts of project’s cash flows were converted into US dollars. Depreciation values were calculated using salvage value of all three investments and 4-year direct depreciation for each investment. Table 2 shows the results of conversion, calculation of EBIT, tax values provided that effective tax rate for FedEx Corporation is 37.5%, and operating cash flows.

Year

Revenue

Purchase of office supplies

Direct and indirect labor

Marketing expense

Depre-ciation

EBIT

Taxes

Net income

Operating cash flow

0

$0.00

$0.00

$0.00

$390.79

$0.00

($390.79)

$0.00

($390.79)

($390.79)

1

$7,752.24

$19.38

$4,651.35

$775.22

$1,250.00

$1,056.29

$396.11

$660.18

$1,910.18

2

$12,608.71

$9.70

$5,431.45

$669.23

$2,500.00

$3,998.34

$1,499.38

$2,498.96

$4,998.96

3

$12,611.30

$9.70

$5,432.56

$669.37

$3,250.00

$3,249.67

$1,218.63

$2,031.04

$5,281.04

4

$12,618.93

$9.71

$5,435.85

$669.77

$3,250.00

$3,253.60

$1,220.10

$2,033.50

$5,283.50

5

$12,630.27

$9.72

$5,440.73

$670.38

$2,000.00

$4,509.45

$1,691.04

$2,818.41

$4,818.41

6

$12,640.37

$9.72

$5,445.08

$670.91

$750.00

$5,764.65

$2,161.75

$3,602.91

$4,352.91

Table 2. Calculations of EBIT and operating cash flows

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 CFi is the cash flow for year i, and r is the cost of capital (Brigham & Daves, 2009). NPV value for the project equals to $5,251,240, which indicates that the project is potentially profitable and should be accepted.

3. Analysis of economic variables in the United States and in Canada

Government control of economy is more marked than that in the US; for example, labor unions are stronger in Canada than in the US, and the employment in government service industries is significantly higher in Canada. Currently interest rates in Canada are kept at 1%, which is rather low (CIA World Factbook, 2012). Although interest rates in the US are even lower (0.25%), Canadian conditions are also quite favorable for debt financing. However, financial managers should take into account the difference of interest rates. In addition to that, the percentage of taxes and other state revenues in Canada constituted 38.5% in 2011, while for the US this ratio equaled 15% (CIA World Factbook, 2012). Increased taxation base and potentially higher liabilities of an employer should be considered as important factor for evaluating the project’s cash flows (and discounting them, if necessary).

Inflation rate in Canada was only 2.8% in 2011, and only 1.8% in 2010 (CIA World Factbook, 2012). For the United States, this characteristics was 3.0% in 2011 (CIA World Factbook, 2012). Low inflation is a favorable condition for starting a business because NPV analysis is more predictable in such cases. Unemployment rates in 2011 for Canada were 7.40%, and for the US this characteristic was 9.10% (CIA World Factbook, 2012). Overall, the dynamics of economic recovery after recession in Canada has been positive (Giammarino, 1998), and it is reasonable to suggest that there will be favorable economic conditions in Canada for the project’s period. Investments in Canada have slightly different dynamics compared to the USA: Gross fixed investment in Canada was 22.7% in 2011, and in the US it was only 12.40% (CIA World Factbook, 2012).

One significant difference of Canadian financial policy is that its government is tending to keep budget balance close to zero, while the approach of the US government is to rely on significant budget deficit (Williamson, 2011). This feature of Canadian policy increases the financial pressure on new projects.

GDP per capita in Canada constituted $40,300 in 2011 (CIA World Factbook, 2012). For the United States, GDP per capita was $48,100 (CIA World Factbook, 2012). Performance of Canadian workers is estimated as 80% of the performance of similar US workers (Giammarino, 1998). Thus, the economy of the US can be viewed as relatively more efficient, and this should be taken into account when launching the project.

The dynamics of exchange rates of USD and CAD can be estimated using the yield to maturity of US and Canadian government bonds. Applying the results of interest rate parity equation to YTMs, it is possible to suggest that in 6 years, exchange rate of USD and CAD will increase by 0.34%. The stability of Canadian policy and relationships with the US indicate that it is reasonable to suggest that exchange rates will not significant affect the project’s outcomes.

One important feature of Canadian investors is cautiousness and risk-averse behavior (Giammarino, 1998), and these variables should also be considered by financial managers in the process of estimating the investments.

Exit mobile version