Determining Highsky’s Market Value Capital Structure

Adjusting cash-flows for flotation costs

In accordance to Damodaran (2016), flotation cost can be referred to as an expense which is incurred during the process of raising additional capital. The amount of flotation cost is usually relating to the amount and type of capital which is being raised.  The treatment followed by the company to adjust cash flow against flotation cost is appropriate because of the flotation cost of projects actually affected as a reduction in initial cash flow. Thus, in this method first NPV of the project is calculated, and then flotation cost is reduced.  Due to same reason, it is preferred by the analyst. 

Table 1: Computation of after-tax cost of each source of financing

According to Cornwall, Vang and Hartman (2016), capital asset pricing model refers to a model which expresses the connection between systematic risk and anticipated return for assets, especially inventories. Further, it is widely utilized during the finance for the pricing of perilous securities, producing an anticipated return for assets specified the risk of those assets and estimating the cost of capital.  In accordance with this method the cost of equity is:

Ke = Krf + b (Km – Krf)

Ke = cost of equity

Krf = Risk-free rate

Km = Equity market required to return, i.e. expected return on the market portfolio

b = beta 

The growth factor is believed to be a key variant in evaluating the value of common stock (Albuquerque, Eichenbaum, Luo and Rebelo, 2016).  The most common method applied for selecting growth rate for a company is to utilize the estimate of the analyst. Another method which can be applied for calculation of growth rate is

= Current EPS – Prior EPS / Prior EPS.

In order to apply this method in a case when data of more than two years are available than taking growth in earning from the first year to last year and then divide same with no. of years. Every method has its own limitation thus in the present method is wide fluctuation in annual EPS, and the impact of compounding effect of the growth rate of EPS is not considered while calculating growth rate. 

Figure 1: company’s weighted marginal cost of capital (WMCC) 

By considering the IRR of the available projects following is the ranking of available projects:

Company should select project on the basis of IRR, to generate higher returns. 

Table 2: Investment decision on marginal basis

Company will invest in project B but not in Project E and A, because despite of increase in capital there is reduction in return. Further, they will invest inn Project F as with the increase in invested amount there is increase in return and remaining projects will be rejected because despite of increase in capital there is reduction in return. 

Calculating the after-tax cost of each source of financing

WACC as per given ratio

Above shown capital structure is more appropriate because; it  have reduced WACC in comparison to previous capital structure. 

Table 3: Statement showing Impact of funding options on EPS (In $)

As per the above statement, it can be noticed that if funds are raised by issuing new equity shares, then EPS will be decreased to $0.31 from $0.34 

As per the above statement, it can be noticed that if funds are raised by raising debt, then EPS will be increased to $0.48 from $0.34 

Table 4: Statement Showing EPS with increased EBIT with both the Finance Alternatives

Table 5: Statement Showing EPS with decreased EBIT with both the Finance Alternatives

 Table 6: Statement showing Computation of Indifference Point

At this EBIT, there will make no difference whether funding is done through equity source or debt source.  

The heuristic representativeness results in a misconception of probability called gambler’s fallacy; this is considered as the belief that when the sequence of trails has all the similar results, then the reverse result is more expected to take place in the next chance, as common changes are apparent to be more representative. In a situation where then is a long-term of the red held on the roulette when, then it is the possibility of a gambler to pick the black ball without considering that the roulette has an absence of memory and is not considered as self-correct, so it is more likely to pick black ball after winning several red balls (Tversky and Kahneman, 1974). However, I am up for the next bet; I will select red it is because black is not the right choice merely on the basis of the fact that red had occurred previously as each turn is not affected by the previous turn, and it is independent in nature. 

In this case, it was stated about an individual in the samples whose name was Ben; he was 30 years old, motivated and highly able, well-liked and successful. By considering this case, it was judged that the possibility that Ben was a lawyer to be 50%, despite the fact that if or if not sampling of him was done from the population. The base rate was ignored by the subjects and judgement on the description was made, as there was there was equal representation of the lawyer and an engineer. It tends that the fact that distributed the subjects were the narrative information, making a comparison of their samples through representativeness judgements and neglecting the earlier possibilities (Tversky and Kahneman, 1980). 

An associated bias, in this case, is probability matching; it takes place when choice differ when it comes to the probability of various events; a distinguishing has been made by the author on rate overlook and probability matching. Furthermore, the rate neglect base is engaged with the discounting the comparative frequency while there is the occurrence of an event. However, the probability matching takes place when the probabilities of the different events are reflected by reactions instead of the probability of a particular event (Sniezek and Henry, 1989). As in the question, the bomber pilots were permitted to take either a flak jacket or a parachute at each turn; it is because it possesses so much weight to carry both. Attacked repeatedly from the enemies, states that it would be more likely to be shot down, the flak jacket comparatively provides better safety when it comes to guns, while the parachute provides better safety in terms of being shot down. In an objective manner, the gunshot of the enemy was more expected, and it is more effective to take the flak jacket because of its probability and protection. Thus, the flak jacket would be considered by me three times, and on the last fourth chance, the parachute will be taken. 

References

Albuquerque, R., Eichenbaum, M., Luo, V.X. and Rebelo, S., (2016). Valuation risk and asset pricing. The Journal of Finance, 71(6), pp.2861-2904.

Cornwall, J.R., Vang, D.O. and Hartman, J.M., (2016). Entrepreneurial financial management: An applied approach. Routledge.

 Damodaran, A., (2016). Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.

Tversky, A., & Kahneman, D. (1974). Judgment under uncertainty: Heuristics and biases. science, 185(4157), 1124-1131.

Tversky, A., & Kahneman, D. (1980). Causal schemas in judgments under uncertainty. Progress in social psychology, 1, 49-72.

Sniezek, J. A., & Henry, R. A. (1989). Accuracy and confidence in group judgment. Organizational behavior and human decision processes, 43(1), 1-28.

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