Report of the assignment:

A. First of all I select two companies stock’s GRICENERAL ELECTRIC and GENERAL MOTER from www.yahoo.com there in that yahoo page I visit yahoo finance after that I click on market data than select stock option and then I choose this two companies monthly stock the company’s stock I selected is for the periods of 2011, 2012and 2013.

Report of the General Electric Company (GE) Company A:

A. As I mention above the data and selection of the companies and their stocks. For this assignment our first requirement was to find out the wacc of the company for that first we need to calculate weightages of debt (Wd ) ,weightages of equity (We), cost of debt (kd) and cost of equity (ke).

I. For calculation of weightages of debt first I find total long term liabilities and total equity for the three years which is Liabilities (2011 ‘345860000’ 2012 ‘307140000’ and 2013 ‘286661000) and Equities(2011 ‘116438000’ 2012 ‘123026000 and 2013 ‘130566000’)

II. After the summation of total long term Liabilities and total equity I find Wd and We for the three years which is (Wd=total long term Liabilities/ sum of total long term liability and equity) We= total equity / sum of total long term liability and equity).

III. After that I average the three years debt and equity for the purpose to find average Wd and We. Average Wd was 71.64% which we assumed as 70% and average We was 28.36% which we assumed as 30%. Our debt to equity ratio was 2.33.

IV. Then I calculate the cost of Debt (Kd) for that first I find interest expenses from the income statement of General electric company for the given three years. By the help of interest expenses I calculate cost of debt easily which is the division of interest expenses our total long term liability (kd=interest expenses/total long term liability).

V. By tacking average of the three years Kd our average Kd we calculated as 3.50%.VI. Also for wacc we need to calculate tax rate for that I select EBT and income tax

expenses for the given three years from the income statement of General Electric Company. By the help of that I calculate effective income tax rate for each periods (Formula is ‘’Effective income tax rate= Income Tax Expense/EBT’’).

VII. For each year effective income tax rate was (2011 ’28.50%, 2012 ’15.69%, 2013 ‘4.19%’) by tacking average of this three years income tax rate our average income tax rate we calculated as 16.12% but we assumed 16%.

VIII. For calculation of wacc we need to find out the cost of equity we calculated cost of equity using capm (capital asset pricing model),.

IX. CAPM=RFR+(β*(RM-RFR)X. RFR is the united states treasury bill rate which is free of default risk some time

having risk but some degree of chances like inflation risk, exchange rate risk etc. which is already given by the instructor.

XI. We calculate beta (β) and market return (RM) by using historical prices (Jan 1, 2011-dec 31, 2013) of General Electric company and standard and poor 500 (S&P 500.

XII. By the help of this historical prices I calculate TR of the Market (S&P 500) and TR General Electric (TR’RI’)

XIII. Formula for total return is TR=(CLOSING PRICE-BEGENING PRICE)/ BEGENING PRICE

XIV. After calculating the TR of MR and RI, I calculate the average return of the market (RM) and average RFR, which is (RM=0.00426) and (RFR=1.84).

XV. Then I calculate the existing beta (β) of the firm for that I calculate equity risk premium of GE (ERP “RI-RF’’ of GE ‘’Y’’) and Market risk premium (MRP S&P 500’’X’’)

XVI. By tacking slope of y and x I calculate existing beta which is 1.00323.XVII. Now for the calculation of cost of equity for capm we have all the information.

By using capm cost of equity calculated as Ke=(0.55%) which is negative and still very low so i assumed cost of equity double of cost of debt which is 3.50% so assumed Ke is 7% or o.07.

2 Now we have all the information for calculating the wacc which is our first requirement of the assignment.i) We know that WACC=Wd*Kd(1-T)+We*Ke+Wp*Kpii) Wd=70%, We=0.30%, Kd(1-t)=0.029, Kd=0.035, β=1.0032, so by putting the

values we calculating WACC is 0.04158 or 4.16%.B. Now our second requirement is to calculate the optimal capital structure. For that first

build different firm structures with deferent debt and equity ratio by the deference of 10%.for that we also find different beta’s like our exiting beta is levered which is 1.0032

we also calculated unlevered beta using levered beta formula is (Bu¿ BL

[1+ (1−Tc )×(DE )] ) unlevered beta calculate is 0.737647 using this unlevered beta we calcite the levered

beta for the different time periods using formula as BL¿BU∗[1+(1−Tc )×(DE )]

I) Kd for existing Beta is 4.50 for the other periods we calculate Kd is 5% increase and decrease.

II) We calculate Ke using capm using the same RFR , beta, and RM. Which is negative in each capital structure so we assumed ke is the double of ke which is (Kd*2).

III) We calculate wacc using the same method (formula) mentioned above.IV) Than for the calculation of value of firm (v=FCF(1+g)/(wacc-g). for the calculation

of FCF(formula is FCF=OCF-∆NOWC-∆F.ASSETS) where is operating cash flows equal to (OCF=EBIT(1-T)+DEPRECIATION) We use EBIT value of the last year which is 26267000, EBIT(1-T)=22064280, OCF=31826280, ∆NOWC=12420000, ∆F.Assets=(24586000) and FCF=43992280

V) Now for the calculation of the value of firm we also need to calculate the growth rate of the firm (GROWTH RATE=ROE*(1-PAYOUT RATIO). Where is ROE=11.07% and Payout ratio=63.00% and growth rate =0.040959.

VI) Now we have the entire requirement’s to calculate value of the firm. We know that v=FCF(1+g)/(wacc-g). by putting the values we have find firm values of different capital structure.

VII) Our optimal capital structure is:

DEBT

EQUITY

D/E β Kd

Kd(1-T) Ke

Assumed Ke

WACC Vo E

10% 90%

0.11

0.806494

3.50%

2.94%

-1.8376564 0.07

0.06594

1848359039

1663523136

Where WACC is low than each capital structure and where the firm value is higher than all so we can say it’s the best capital structure for the firm.

C. Our third and last requirement is to calculate business risk, financial risk and total risk of the firm.

I. For that first we need EBIT and N.I values for the three given years. By the help of that values I calculate the std of EBIT (std of EBIT=1889389.3) and std of N.I= 261717.83.

II. After that I calculate average of EBIT and N.I which is (EBIT avg=17487000) and (N.I avg=13272667.

III. After that I calculate business risk, financial risk and total risk easily.IV. Business risk is simply the CV of EBIT=std of EBIT/ avg of EBIT =0.1080 V. Where is Firm risk equls to std of N.I/avg of N.I =0.0197

VI. And financial risk is simply the deference between business risk and firm risk which is (0.0883).

Company B: General Motors Company (GM)

A) Our first requirement Is to find out the wacc of the company for that first we need to calculate weightages of debt (Wd ) ,weightages of equity (We), cost of debt (kd) and cost of equity (ke) listed above in company A.

XVIII. For calculation of weightages of debt first I find total long term liabilities and total equity for the three years which is Liabilities (2011 ‘52386000’ 2012 ‘58430000’ and 2013 ‘60758000) and Equities(2011 ‘38120000’ 2012 ‘36244000’ and 2013 ‘42607000’)

XIX. After the sum of total long term Liabilities and total equity I find Wd and We for the three years which is (Wd=total long term Liabilities/ sum of total long term liability and equity) We= total equity / sum of total long term liability and equity).

XX. After that I average the three years debt and equity for the purpose to find average Wd and We. Average Wd was 59.46% which we assumed as 60% and average We was 40.54% which we assumed as 40%. Our debt to equity ratio was 1.50.

XXI. Then I calculate the cost of Debt (Kd) for that first I find interest expenses from the income statement of General Motors company (GM) for the given three years. By the help of interest expenses I calculate cost of debt easily which is the division of interest expenses our total long term liability (kd=interest expenses/total long term liability).

XXII. By tacking average of the three years Kd our average Kd we calculated as 0.81% which is very low so we assumed Kd as US treasury ytm (10 years)=4.50%.

XXIII. Also for wacc we need to calculate tax rate for that I select EBT and income tax expenses for the given three years from the income statement of General Motors Company (GM). By the help of that I calculate effective income tax rate for each periods (Formula is ‘’Effective income tax rate= Income Tax Expense/EBT’’).

XXIV. For each year effective income tax rate was (2011 ’(1.20%), 2012 ‘121.38%, 2013 ’28.52%’) by tacking average of this three years income tax rate our average income tax rate we calculated as 49.57% but we assumed 50%.

XXV. For calculation of wacc we need to find out the cost of equity we calculated cost of equity using capm (capital asset pricing model),.

XXVI. CAPM=RFR+(β*(RM-RFR)

XXVII. RFR is the united states treasury bill rate which is free of default risk some time having risk but some degree of chances like inflation risk, exchange rate risk etc. which is already given by the instructor.

XXVIII. We calculate beta (β) and market return (RM) by using historical prices (Jan 1, 2011-dec 31, 2013) of General Motors company (GM) and standard and poor 500 (S&P 500.

XXIX. By the help of this historical prices I calculate TR of the Market (S&P 500) and TR General Electric (TR’RI’)

XXX. Formula for total return is TR=(CLOSING PRICE-BEGENING PRICE)/ BEGENING PRICE

XXXI. After calculating the TR of MR and RI, I calculate the average return of the market (RM) and average RFR, which is (RM=0.00426) and (RFR=1.84).

XXXII. Then I calculate the existing beta (β) of the firm for that I calculate equity risk premium of GE (ERP “RI-RF’’ of GE ‘’Y’’) and Market risk premium (MRP S&P 500’’X’’)

XXXIII. By tacking slope of y and x I calculate existing beta which is 0.99655 OR 99.7%.XXXIV. Now for the calculation of cost of equity for capm we have all the information.

By using capm cost of equity calculated as Ke=0.43039 or 43%.XXXV. Now we have all the information for calculating the wacc which is our first

requirement of the assignment.iii) We know that WACC=Wd*Kd(1-T)+We*Ke+Wp*Kpiv) Wd=60%, We=40%, Kd(1-t)=0.225, Kd=0.45, β=0.997, so by putting the values

we calculating WACC is 0.3071555 or 30.72%.B) Now our second requirement is to calculate the optimal capital structure. For that first

build different firm structures with deferent debt and equity ratio by the deference of 10%. For that we also find different beta’s like our exiting beta is levered which is 0.997

we also calculated unlevered beta using levered beta (formula is (Bu¿ BL

[1+ (1−Tc )×(DE )] ) unlevered beta calculate is 0.5697143 using this unlevered beta we calculate the

levered beta for the different time periods using formula as BL¿ BU∗[1+(1−Tc )×( DE )]VIII) Kd for existing Beta is 4.50 for the other periods we calculate Kd is 5% increase

and decrease.IX) We calculate Ke using capm using the same RFR , beta, and RM. Which is

negative in each capital structure so we assumed ke is the double of ke which is (Kd*2).

X) We calculate wacc using the same method (formula) mentioned above.

XI) Than for the calculation of value of firm (v=FCF(1+g)/(wacc-g). for the calculation of FCF(formula is FCF=OCF-∆NOWC-∆F.ASSETS) where is operating cash flows equal to (OCF=EBIT(1-T)+DEPRECIATION) We use EBIT value of the last year which is 7792000, EBIT(1-T)=3896000, OCF=12051000, ∆NOWC=3085000, ∆F.Assets=3549000 and FCF=3549000

XII) Now for the calculation of the value of firm we also need to calculate the growth rate of the firm (GROWTH RATE=ROE*(1-PAYOUT RATIO). Where is ROE=10.89% and Payout ratio=20.00% and growth rate =0.08712 or 8.71%.

XIII) Now we have the entire requirement’s to calculate value of the firm. We know that v=FCF(1+g)/(wacc-g).

XIV) By putting the values we have find firm values of different capital structure.XV) Our optimal capital structure is:

DEBT

EQUITY

D/E β Kd

Kd(1-T) Ke

WACC Vo E

80% 20%

4.00

1.7091429

5.50%

3.91%

0.7284

17.69%

42968417.55

8593683.509

Where WACC is low than each capital structure and where the firm value is higher than all so we can say it’s the best capital structure for the firm.

C) Our third and last requirement is to calculate business risk, financial risk and total risk of the firm.

i) For that first we need EBIT and N.I values for the three given years. By the help of that values I calculate the std of EBIT=17441061.25 and std of N.I= 1604550.

ii) After that I calculate average of EBIT and N.I which is EBIT avg=(3565667) and N.I avg=5404667.

iii) After that I calculate business risk, financial risk and total risk easily.iv) Business risk is simply the CV of EBIT=std of EBIT/ avg of EBIT =(4.8914) v) Where is Firm risk equls to std of N.I/avg of N.I =0.29688vi) And financial risk is simply the deference between business risk and firm risk which

is 5.18827.