Associate Bearings Company Limited

Q1. What is ABCLs cost of debt? Would you include the current liabilities in debt, why, why not? ABCLs cost of debt can be calculated by finding the interest paid as a percentage of the total debt, the total debt will include both short term and long term debt. The tax rate is assumed to be 35 % as from the PAT values, the tax rate comes to be different for each year which is not possible. The cost of debt is calculated for each year and then averaged to find the mean cost of debt. Hence ABCLs cost of debt is found to be 6.89% (Refer Excel Sheet) Current liability is not included in debt because it is deployed only to finance the working capital of the firm, where as debt is raised by a firm to undertake capital expenditure.

Q2. ABCL has not raised any equity capital in the last five years and used its retained earnings for financing, since it has no obligation to pay dividends on retained earnings, do you agree that they are cost free source of funds? No, since, retained earnings are a part of the shareholders equity and a part of the profit that should be paid to the shareholders, so when ABCL is paying a dividend from its retained earnings; it is incurring a cost of equity. Hence, these are not cost free source of funds. Q3 Calculate Cost of Equity based on DGM and CAPM? Which is better? With reference to the excel sheet Cost of Equity based on DGM: 17.2% Cost of Equity based on CAPM: 9.5% The Cost of Equity based on the CAPM model gives a more accurate value of the cost of equity since it takes into account the historical data and the markets rate of return. Thus it represents a more real picture of the cost of equity. Q4 What is ABCLs Weighted Average cost of capital (WAAC) ? Refer the Excel sheet The Weighted Average Cost of Capital (WACC) of ABCL based on the historical cost of debt and cost of equity calculated using the Dividend Growth Model was found to be 12.78%.

Q5 Would you agree that all the companies in ball bearing industry have approximate same cost of capital? The costs of capital of the various companies in the ball bearing industry were calculated based on the Dividend Growth Model. Following are the Weighted Average Cost of Capital values: (With reference to the excel sheet) ABCL: 12.78% BIMETAL: 11.14% ANTIFRICTION: 10.55% FAG PRECISION: 10.21% Thus the companies have different costs of capital.

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