Running head: INTERNATIONAL CORPORATE FINANCE

International Corporate Finance

Student Name

Course
INTERNATIONAL CORPORATE FINANCE 2

Outline

Introduction of Company..................................................................................................2

Estimation of Risk-free rate..............................................................................................2

Estimation of Equity Market Risk Premium......................................................................2

Estimation of

Beta…………………………………………………………………………………………….…2

Estimation of Cost of Equity using CAPM........................................................................3

Estimation of Cost of Debt............................................................................................... 3

Estimation of the WACC.................................................................................................. 4

Explanation of WACC...................................................................................................... 5

WACC for valuing Foreign Subsidiary Projects................................................................5

References.......................................................................................................................6
INTERNATIONAL CORPORATE FINANCE 3

International Corporate Finance

Introduction of Company

The company selected for the estimation of its weighted average cost of capital is

Bayerische Motoren Werke (BMW AG), which is listed on the Frankfurt Stock Exchange

under the Xetro trading system. The company has its headquarters in Munich,

Germany. It produces motorcycles, automobiles and also aircraft engines. In 2015, the

company became the twelfth largest vehicle producer of motor vehicles around the

world.

The company currently has 134,682 employees and has 30 production locations

around 14 countries of the world. The company delivered a total number of 2.49 million

automobiles to the customers in 2018 and generated total revenue of EUR 97.48 billion.

The company also has a strong motorsport history especially in sports cars, Formula 1

and touring cars (BMW, 2019). In this report, analysis is performed to estimate the

WACC for BMW AG and analyze its different components.

Estimation of Risk-free rate

The risk-free rate can be called as the theoretical return on the investments that

have zero risks. A bund, on the other hand, is a debt security that is issued by the

government in Germany, and it is equivalent to the US treasury bonds. The yields of

these bunds could be used as the risk-free rate. The Germany bund 10-year yield is

0.00%, and the 30-year yield is 0.63% (Bloomberg, 2019). Since this is a long term

investment, therefore, the risk free rate would be estimated to be at 0.63%.

Estimation of Equity Market Risk Premium

The equity market risk premium is the excess return generated by an investor in

of the risk-free rate. The current market risk premium in Germany is 8.32% (Market

Risk Premia, 2019). The market return can also be estimated the by adding the risk-free

rate in the equity risk premium. The market return would be: 8.32% + 0.63% = 8.95%.

Estimation of Beta

The beta of a stock is the coefficient that measures the systematic risk or the

volatility of the stock compared to the market’s overall unsystematic risk. The beta is an

important variable that is used in the capital asset pricing model, especially the levered

beta or beta equity. The current beta equity for the BMW stock is 0.80 based on 3 years

monthly returns (“Yahoo Finance”, 2019).

Estimation of Cost of Equity using CAPM

The capital asset pricing model is used to compute the cost of equity. The cost of

equity cannot be calculated directly from financial statements, like the cost of debt. This

is because the cost of equity is the required rate of return for the equity holders and

must be paid to them. The formula for the CAPM model is as follows:

Required Return (Ke) = Rf + (Rm - Rf) x Beta Equity

All the required variable have been estimated for this model, the cost of equity can now

be estimated as follows:

Ke = 0.63% + (8.32% x 0.80)

Ke = 7.29%

Estimation of Cost of Debt

The cost of debt is the interest costs or charges paid by the company on its debt

obligations. Since the annual reports of BMW do not mention their average or current

interest rate, estimation can be done for cost of debt. The total long term debt for the

company in 2018 was EUR 59705 million, and the total interest costs were EUR 386

million (“Morningstar”, 2019). This provides the before tax cost of debt of 386/59705 =

0.65%. The 5 year average tax rate for BMW has been equal to 31.71% (“Reuters”,

2019). This gives us an after tax cost of debt of 0.65% x (1-31.71%) = 0.44%.

Estimation of the WACC

Since the automobile business is highly capital intensive, these companies

extensively make use of debt financing. The current debt to capital ratio for BMW is

63.63%, and this means that the remaining portion of 1-63.63% = 36.37% is equity in

the capital structure. This shows that the company has 1/3rd of equity and 2/3rd of debt

financing in its capital structure. Using these proportions, the WACC can now be

estimated as follows:

WACC = (Ke x E%) + (Kd x D%)

WACC = (7.29% x 36.37%) + (0.44% x 63.63%)

WACC = 2.93%

The computations have also been performed in the excel spreadsheet, and these are

summarized in the table below which is computed in excel:

BMW WACC

Germany 30 Year Bund Yield 0.63%

Equity Risk Premium 8.32%

Market Return 8.95%

Beta of BMW 0.8

Cost of Equity 7.29%

Total LT debt (2018) million 59705

Total Interest Costs - million 386

Before tax cost of debt 0.65%

5 Year Average Tax Rate 31.71%

After tax cost of debt 0.44%

Current Debt to Capital 63.63%

Equity % 36.37%

WACC 2.93%

Explanation of WACC

Companies evaluate and appraise their projects through capital budgeting, and

one of the most important investment tools in capital budgeting is the WACC. When the

valuation of the investments is performed, the WACC is used by the security analysts to

value them. WACC also plays a crucial role in valuing a business. All the free cash

flows from the business are discounted back at its WACC to calculate the present value

of the free cash flows and the resulting value of the business. Furthermore, economic

value added calculations also require the use of WACC in its formula.

WACC serves as the reality check for all the projects and the investments of the

firm. The WACC incorporates the risk of an investment and the level of the risk faced by

the firm and utilizing this combination; it gives the NPV value. The NPV then shows that
INTERNATIONAL CORPORATE FINANCE 7

whether the respective project generates wealth or it can destroy it. Other important

uses of WACC are in the EVA computations, valuation of mutually exclusive projects

with the same or different level of risk and other investment decisions.

WACC for valuing Foreign Subsidiary Projects

An MNC that wants to evaluate the projects of its foreign subsidiaries must use a

different WACC and should not use the WACC of its parent company. This is because

the level of risk of the parent company and its subsidiaries are operating in different

countries. Also, if the foreign subsidiary obtains all the financing for its projects from its

own sources, then the MNC must compute its foreign cost of capital to reflect the same

level of risk as shown by the project. Other specific factors like country risk, market risk

premium and exchange rate also have an impact on the MNC's foreign operations.

Therefore, it is feasible to compute its own WACC for valuing the projects.

References
INTERNATIONAL CORPORATE FINANCE 8

Bloomberg. (2019, April 9). German Rates & Bonds. Retrieved

from:https://www.bloomberg.com/markets/rates-bonds/government-bonds/

germany

BMW. (2019, April 9). BMW Group Key Figures. Retrieved from

https://www.bmwgroup.com/en/company.html

Market Risk Premia. (2019, April 9). Retrieved from http://www.market-risk-

premia.com/de.html

Morningstar. (2019, April 9). Retrieved from http://financials.morningstar.com/balance-

sheet/bs.html?t=XETR:BMW&region=deu&culture=en-US

Reuters. (2019, April 9). Retrieved from

https://www.reuters.com/finance/stocks/financial-highlights/BMWG.DE

Yahoo Finance. (2019, April 9). Retrieved from

https://finance.yahoo.com/quote/BMW.DE/?guccounter=1