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# Debt and Equity

Investment Analysis

� Compare this to an industry average or a main competitor. What are the differences?
� Based on what you know about your selected company, do these differences seem appropriate?
� Relate your company’s capital structure choices to the appropriate capital structure theory (ies).
Also, as a component of your executive summary, obtain the current stock price for your company and
use it as an additional calculation. Based upon all of your research, would you recommend investing in

INVESTMENT ANALYSIS 2

Debt and Equity

Competitive Review of Debt and Equity Mix

The cost of equity is more expensive than the cost of debt. But the optimal structure of the
company shows that equity capital is preferable to the company than the debt. The ratio of debt
to equity in 2014 – 2012 was 4:6

APC 2014 2013 2012
Equity 19,725 21,857 20,629
Debt 15092 13065 13269
debt/Equity 0.4 0.4 0.4

Table 5
Market Value of Equity

APC 2014
Shares outstanding 52 million
Price as of 13.36 per share
Market value of equity 721 million
CAPM 27.35

Debt
The cost of debt for APC for 2014 was 5.1 while for the years 2013 and 2014 it was 5.2 and 5.5
respectively.

INVESTMENT ANALYSIS 3

APC (millions) 2014 2013 2012
Long term
Loan

15092 13056 13269
Interest paid 772 686 742
Cost of debt 5.115 5.254 5.592

Table 6
Cost of Debt

APC 2014
Long term debt
Current Portion of Debt
Total Debt

## 15092 m

15092
Cost of Debt % before taxes 4%
Tax Rate 35.8%

(5)

Weighted Cost of Capital
Table 7
Weighted Cost of Capital Raw Data

Company name Value \$ %

INVESTMENT ANALYSIS 4
Equity (R s )   19,725   0.566
Debt (R b ) 15092 0.433
Total Value 34,817 1

(6)

= 15,092/34817 x 0.57 + 15092/34817 x 0.47 (1-0.358)
= 4.51%
Capital Budgeting Assumptions
The assumptions made are that the business has been taken as a going concern and it has been
assumed that the directors of the business have no intention of closing the company in the near
future (Brooks & Mukherjee, 2013).
Capital Structure Theories
The capital structure of APC reveals that the debt to equity ratio 4:6. It means that the ratio is
optimal for the operations of the company. The capital structure theories can be traced to
Modigliani and miller. The theories assume that the cost of capital is reflected by the country’s
risk free rate which is also assumed to be constant while the growth rate is assumed to be zero as
all the earnings supposedly paid out as dividends. The investors are assumed to have
homogenous expectations while the market is perfect. The risk free rates have been taken as 4%
while the calculated interest rates for APC are approximately 5% (Ross, Westerfield & Jaffe,
2013).

INVESTMENT ANALYSIS 5
The theories state that the cost of equity is more expensive than the cost of equity especially
where the concerned company has a lot of assets. The trade off theory applies partially to the
capital structure of the firm as its struggling to maintain a balance between the debt and equity
capital.

Summary

The shares of the company are fair and the prices of the shares are also high. In the last five years
the shares of APC have fluctuated constantly between 80 and 83 but the lowest share price was
47.41 recorded in August 2010 while the highest was 112.69 recorded in August 2014. At 84.79
dollars the shares are very expensive but the company is facing a positive future given that the
profits are reducing (Berk, DeMarzo, Harford, Ford, Mollica & Finch, 2013).
The company should analyze why the cost of sale is increasing rapidly from 10% in 2013 to 13%
in 2014. I would certainly not invest in this company in the short term as the profits are currently
non-existent and the situation is worsening. The net income for the last financial period dropped
by a significant margin while the cost of goods also increased from 10% in 2013 to 13% in
2014.

INVESTMENT ANALYSIS 6

Reference

Ross, S. R., Westerfield, R. W., &Jaffe, J. (2013). Corporate finance (10 th ed.). NY: McGraw-
Hill.
Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V., & Finch, N. (2013).
Fundamentals of corporate finance, Pearson higher education au.
Brooks, R., & Mukherjee, A. K. (2013). Financial management: Core concepts. Pearson.
Yahoo Business Finance (n,d) APC retrieved June 25 2015 from
http://finance.yahoo.com/echarts?s=APC+Interactive#{%22range%22:%225y%22,%22allowCh
artStacking%22:true}

INVESTMENT ANALYSIS 7

Appendix A

Anadarko Petroleum Corp Year 2014 Year 2013 Year 2012
Net Income -17,750 801 2,391
Revenue 18470 14581 13411
Assets 61,689 55,781 52,589
Equity 19,725 21,857 20,629
Debt 15092 13065 13269
GP 15,085 11,598 10,717

INVESTMENT ANALYSIS 8

Appendix B

INVESTMENT ANALYSIS 9

Appendix C