Figuring out Cost of Equity for Ford CO
This weekly puzzle asks you to estimate the Cost of Equity forFord Motor Co (ticker: F) look at how the way that youcalculate it can affect your estimate of value.
The questions below:
- Estimating the Cost of Equity (using CAPM)
Reference Formula: Cost of Equity =Risk Free Rate + (β x Equity Risk Premium)
[Note: we refer to β as âbetaâ)
This weekly puzzle asks you to estimate the Cost of Equity forFord Motor Co (ticker: F) look at how the way that youcalculate it can affect your estimate of value.
The questions below:
- Estimating the Cost of Equity (using CAPM)
Reference Formula: Cost of Equity =Risk Free Rate + (β x Equity Risk Premium)
[Note: we refer to β as âbetaâ)
I Have the risk free rate of2.75%
And the Equity Risk Premium is4% to 5.5 %.
- Estimating âbetaâ (using a published source). Letâs startsimple and simply look up an estimate of beta online!
- What is your estimate of beta?
- Where did you find that information, and why did you choose thesource that you did?
- Estimating âbetaâ (using fundamentals). Now letâs estimate aâfundamental betaâ using Damodaranâs methodology:
Reference Formula (simple form):βLevered = βUnlevered x (1 +Debt/Equity))
- Look up the unlevered beta for this companyâs industryon Damodaranâs data page: what is your estimate of the âunleveredbetaâ?
- In order to calculate the debt/equity ratio, we need to findthe market values of equity and debt:
Part 1: What is the market valueof equity, and where did you find this information?
Part 2: What is the balancesheet value of the debt? (Note: just look up thesummary information on FINRA, you donât need to pull the 10Q forthis.)
Part 3: What is your estimate of themarket value of debt, and how did you calculate it?
Part 4: What is the Debt/Equity Ratio for this Company, and howdifferent would your answer be if youâd just used the balancesheet value of debt?
- You should now have all the data that you need to produce afundamental estimate of this companyâs âlevered betaâ: do thecalculation and write your answer below.
- How does the value of âbetaâ that you looked up online comparewith the value that you just estimated?
- If you want to think about how this companyâs Cost of Equitywould change if it chose to use a different financing mix (ie, moredebt, less equity), which of these approaches would be more usefulto you?
- Estimating the Cost of Equity:
- Use your answers to the questions above to estimate the Cost ofEquity.
You should find more than one answer, as you calculated âbetaâ intwo different ways: what is your range of estimates forthe Cost of Equity?