Question

Comment this discussion :

Sources of long term finances for Genesis Energy may be money market securities, capital market securities, bonds, valuing common stock, or valuing preferred stock. A benefit of money market securities is quick access to the cash with low risk. Capital market securities include stocks and bonds that are a term of a year or longer. Examples are corporate bonds, or common or preferred stock.

Corporate bond risk depends on the financial health of the corporation. Benefits of corporate bonds also depend on the financial health of the corporation and can be long term for years. Common stock is higher interest rate with higher risk. Common stock does not appear to have term limits or limits on maturity. Preferred stock has more risk than corporate bonds. Benefits of preferred stock depend on the rate of return.

Investor risk to help Genesis Energy involves the ability of Genesis to effectively manage their debt to assets and pay off the liabilities. The investors will most likely expect to get a large rate of return. Investors will want to be paid higher dividends which is known as the weighted average cost of capital (WACC).

According to Gurufocus.com “As of today, Apple Inc's weighted average cost of capital is 9.8%. Apple Inc's ROIC % is 28.53%” (Gurufocus.com, n.d.).

According to Gurofocus.com: “As of today, Genesis Energy LP's weighted average cost of capital is 7.73%. Genesis Energy LP's ROIC % is 4.55%, and Cost of Debt = 129.809 / 3006.7115 = 4.3173%.” (Gurufocus.com, Genesis Energy LP , 2018).

The required rate of return for Genesis Energy shareholders needs to be larger than the weighted average cost of capital. It needs to be larger than 7.74%. If you compare to Apple Inc, Apple’s return on investment is approximately 18% higher than their average cost of capital of 9.8%. Genesis Energy needs to raise capital to bring the return on investment higher to make it worth the sacrifice for investors.

Gurufocus.com. (2018, 02 24). Retrieved from Genesis Energy LP : https://www.gurufocus.com/term/wacc/NYSE:GEL/Weighted+Average+Cost+Of+Capital+%2528WACC%2529/Genesis+Energy+LP

Gurufocus.com. (n.d.). Apple Inc (NAS:AAPL) WACC %:9.8% As of Today. Retrieved 02 24, 2018, from https://www.gurufocus.com/term/wacc/AAPL/Weighted-Average-Cost-Of-Capital-WACC/Apple-Inc

Answer 1

The first part of the discussion is correct that capital market securities are usually of a longer tenure compared to money market securities such as commercial paper or certificate of deposits.

It is also true that investors holding common stock have taken the most risk and consequently demand a higher return than bond holders. The investors expectation of return from the investment in Genesis Energy is more than the weighted average cost of capital (WACC), which is basically the cost of equity, cost of preferred stock and cost of debt weighted by their respective composition in the whole capital structure.

The statement that investors would like to get higher dividend and that this is known as weighted average cost of capital is clearly wrong.

Also the discussion needs to be corrected to state that the return expectations of the Genesis shareholders should be more than the cost of equity of the Genesis Energy. It is unfair to compare the expectations on the return on equity with weighted average cost of capital as WACC is generally lower due to the component of debt and return expectations on equity has to be compared to cost of equity only.

Also Genesis energy needs to raise profitability to increase the return on invested capital rather than raising more capital to increase its return.