Re: Cost of Equity and Debt
Recall that the WACC analysis is meant to capture the MARGINAL cost of capital for the company. As such, you definitely use MARKET VALUE of equity and debt. In reality, for non-distressed companies, we proxy market value of debt by using book value of debt. Minor, immaterial differences, so no worri... Recall that the WACC analysis is meant to capture the MARGINAL cost of capital for the company. As such, you definitely use MARKET VALUE of equity and debt.
In reality, for non-distressed companies, we proxy market value of debt by using book value of debt. Minor, immaterial differences, so no worries.

However, book value of equity is NEVER appropriate for WACC because you don't issue new equity valued based on shareholders' equity (book value), but instead, on the current market conditions. As such, were the stock to tank, and the company issues new equity at that time, (just think back to banks back in the credit crisis), then, yes, they'd be doing it at the worst time. The cost of equity would then rise since clearly the premium required for investors to invest has gone up (by simple virtue of the fact that prices dropped).

Also, we don't think that Shareholders' Equity is intuitively the "actual capital structure of the company" as you noted. Shareholders' Equity is an accounting term fraught with accrual concept of accounting issues. At day one of the company's IPO, it is the actual capital structure. But after that, it's not.

Now, our question to you is the flip opposite - if the stock rose dramatically instead of tanking, would you have the same question? Or you wouldn't have bothered asking this question because "stock prices generally rise not fall" (which is complete BS). The opposite scenario to your question is also true - and that is why companies like to issue more stock when prices are high because you can sell more stock and give up less ownership percentage.

If the price takes a huge hit, the proportion of equity to total cap would decrease, yes. But then the cost of equity capital in theory goes up. Two-way street!

Side Note: when calculating beta, specifically unlevering and then re-levering your competitors' betas for CAPM, the Hermada beta equation uses book value of equity and debt (not market values). This makes sense and isn't mixing apples and oranges because the variability to profits is based on ROE (book value of equity). Refer back to our Corporate Valuation slide materials in comparing Company A (unlevered) with Company B (levered). Read More

Re: Complex Trading Comps Analysis
It depends on the reason for the lower state tax. If "normal" and "ordinary course of business", then no need to adjust.
If it is due to a specific one-time item, then perhaps we would adjust.
what is the specific nature of the tax benefit?

Re: Complex Trading Comps Analysis
We should not adjust the $13,895 because it is merely a change in their estimates to arrive at the correct full year tax number.
This is not the effect of a one-time item, it is simply correcting conservative assumptions from the previous 3 quarters.

Re: Convertible Debt Adjustment
Sorry, but I realized I have a handful of related, follow-up questions to this as well. Admittedly my understanding of convertibles is somewhat limited, which is the source of most of these questions. (4) This is related to the original question of this post: referring to the Costco 10-Q, pg 26, in... Sorry, but I realized I have a handful of related, follow-up questions to this as well. Admittedly my understanding of convertibles is somewhat limited, which is the source of most of these questions.

(4) This is related to the original question of this post: referring to the Costco 10-Q, pg 26, in the Long-Term Debt section, it clearly says that in the 1H of fiscal 2005, $266.6M of principal was converted into 9.4M shares and in 1H of 2006, $164.9M of principal was converted into 5.6M shares. I don't understand how the sum of these share totals is exceeding the max shares convertible figure of 9,430,147 stipulated in the 10-K for the 3.5% zero-coupon converts. My understand of convertibles are that there is a defined amount of shares convertible for each note/bond at a predetermined conversion price. Granted this understanding comes from interest-bearing converts with $1000 par and say 20:1 conversion ratio, i didn't think it would differ in mechanics with zero-coupon. Could you explain this?

(4b) If zero-coupon and int-bearing are different in nature, how so?

(5) As an investor, why don't we compare the current stock price of Costco to its initial conversion price of $22 (per 10-K) for conversion decision making?

(6) Also, for some reason i thought you need to buy the underlying stock from the company as part of the conversion so shouldn't cash and APIC also go up in the accounting entry, not just debt reduction and O/S increase?

(7) Lastly, let's say we were to convert based on the analysis in the 10-K. However, as Hamilton says, we shouldn't pull from differing time periods (much like the cap leases exclusion from the debt calculation). Hence, using the info we got from the 10-K to determine the conversion would be inaccurate since there should be a newer PV of principal on the books as of the 10-Q, except that they don't disclose it. In that case, what do you do? Use best available info, as of 10-K? Or disregard, as with the practice of the cap leases?

Sorry.... so many questions. Read More

AD analysis left-field questions
I had a few side/random questions from the accretion dilution analysis. Finance ONLY purchase price equity (& NOT EV), as quick/dirty model/anal? In other words, I would think that financing would FUND EV (if there is debt, that debt would most likely be refinanced/ repaid/retired, or less co... I had a few side/random questions from the accretion dilution analysis.


Finance ONLY purchase price equity (& NOT EV), as quick/dirty model/anal?
In other words, I would think that financing would FUND EV (if there is debt, that debt would most likely be refinanced/ repaid/retired, or less commonly, assumed/rollover), but most accretion dilution analysis I see FUND ONLY the EQUITY OR OFFER VALUE = (target undisturbed price + prem) * target FD shares (is this because the analysis is quick and dirty and not detailed/complexed)?

PF NI (of both stand-alone cos) is probably marginal/PF (not necessarily normalized/cleansed)?
In other words, I would think that NI of buyer + NI of target SHOULD BE normalized but may sometimes contain marginal one-time items for PF EPS purposes?


Side questions:
For tax rate, I'm thinking that it is usually the statutory rate (adjusted for PF/marginal/forecast factors)?

For PF debt interest rate% (depending on which debt tranche is used for financing), I'm thinking that is the blended/average book (footnote) rate (adjusted for PF/marginal/forecast factors/variables)?

It appears that the accretion dilution analysis is an EPS / income statement / non-cash / accrual analysis - as such it seems like it is not entirely relevant as a cash effect/consequence analysis. If so, how relevant is a cash effect/consequence analysis (I'm thinking that it is relevant but less so, and that these metrics are reflected in the PF leverage/capitalization and ownership statistics)?

How relevant is the additional/incremental (tax deductible or not) D&A ex from asset step/write-up? It seems like alot of the PPA % allocation assumptions originate from in-depth accountant analysis/review, and that its hard to plainly make "standard" assumptions for practical modeling purposes.

Fees are arguably one time items. However, I have seen them included in some (probably) detailed analysis. Should they be included (I didn't see that in WST version). In likely a detailed (more full blown / integrated merger) analysis/model, I would think that the non-financing fees would affect the uses (and thus sources) of funds resulting in higher EV and thus financing costs (to fund that higher EV); financing fees would be capitalized in BS and result in additional amortization costs in P&L and thus lower PF EPS. Read More