Question

Based upon the comments and what you have learned about the capital needs of this company, would you suggest one of the options over the other options discussed to raised the needed capital? If so, which option would you suggest and what would be some of the first steps your company needs to take to begin raising capital using the selected option?

Discussion Comments :

Finance Organization and Long-Term Planning

Genesis Energy, determination of weights :

In general, the company balance sheet Asset are financed by these two elements : debt and equity. We will proceed by calculation of these two weights Equity and debt.

In other fact the market value of equity, it’s also mean “ Market Cap”. Actually, the company Genesis Energy market value equity or market capitalization (E) is estimated at $ 2,130,331; As of December 2016. The market value of debt is complex to calculate, therefore, by the using of book of value debt will help in calculation. To simplify the calculation, it’s easy to add the last two year average short term and Long term together. As of December 2016, the company Genesis energy last two year short term debt was equal to $0 and its last two years long term Debt was estimate at 1,180,111.5 Mil. The total estimation value of debt (D) is $1,180,111.5.

Weight of equity = The market value equity (E) / (E+D)

= $ 2,130,331/($ 2,130,331+$1,180,111.5)= 0.3915

Weight of debt = The value of debt (D) / (E+D)

= $1,180,111.5/($ 2,130,331+$1,180,111.5)= 0.2169

determination of Equity :

The capital asset pricing model “CAPM” for to calculate the require rate return. The equation formula is : cost equity = Risk free rate + Beta of Asset X ( expected return of the market – risk free of return)

During the 10 years of treasury of constant maturity rate as the risk free rate; it is update daily. The actually risk free rate is 2.66%.

The factor Beta is the sensitive of the expected excess asset returns to the expected excess market returns. The company Genesis Energy Beta is 1.53

The premium market = ( expect return of the market – Risk free rate of return ), this premium market requires to be 6%.

Cost of equity = (2.66%+1.53) X 6% =9.499%

Determination of cost debt :

We will use the last year end interest expense divided the last two years average debt will equal the cost of debt.

As od December 2016, the company Genesis Energy interest expense was estimate at $8,350. The total value of debt (D) record is $ 1,807,054. Cost of debt = $8,350/1807,054 = 0.4621%.

The last 2 years tax rate average is 2.143%.

Genesis Energy weight Average Cost “WACC”= E/(E+D) x cost of debt x (1-tax rate)

= 0.3915 x 9.499% x 0.2169 x 0.4621% x ( 1 - 2.143% ) = 2.879%.

Resources:

https://finance.yahoo.com/quote/GEL?p=GEL

https://finance.yahoo.com/quote/GEL/balance-sheet?p=GEL

https://finance.yahoo.com/quote/GEL/financials?p=GEL

Answer 1

To start with a lot depends on how much does the company need as finances to come to a conclusion weather it should go for debt or raise funds through equity.

What is cost of capital (WACC in this case) nothing but opportunity cost to the investors. In simpler words its the rate of return that they would expect to make in other investments of equivalent risk. Offcourse the world will jump to a conclusion that why not go for debt given its benefits like - lower interest, tax exemption, no voting power. But there are risks involved in it too. Therefore a proper mix of both debt and equity - since both are likely to increase as the debt ratio goes up, the former because equity investors will be exposed to more volatile equity earnings, after interest payments, and the latter because default risk will increase with the debt.

If an investor goes for more cost of equity the equity in the firm will become more risky as financial leverage magnifies business risk as a result the cost of equity will increase. If an investor use more debt the default risk as a firm will increase pushing up the cost of debt. At some level of borrowing, your tax benefits may be put at risk, leading to a lower tax rate. The trade off: As an investor use more debt, it replace more expensive equity with cheaper debt but then also increase the costs of equity and debt. The net effect will determine whether the cost of capital will increase, decrease or be unchanged as debt ratio changes.