United States Steel(X) = (9160000-6885000-1000)*1000
=2,274,000,000 USD
Facebook (FB) = (64,961,000-5,767,000)*1000
=59,194,000,000 USD
company shares outstanding share prices market value
United states Steel (X) 176,000,000 $ 35.48 $ 6,244,480,000.00
Facebook (FB) 2,930,000,000 $ 161.89 $ 474,337,700,000.00
company total asset total liability minority interest book value
United states Steel (X) $ 9,160,000.00 $ 6,885,000.00 1000 $ 2,274,000,000.00
Facebook (FB) $ 64,961,000.00 $ 5,767,000.00 0 $ 59,194,000,000.00
For both companies, the book value exceeds the market value. This is an indication that the company is overvalued. It is also an indication that the market has lost confidence in the company at the moment. It can also be an indication that the company has the required asset to generate sales and cash flow in the future. For those investor looking to buy the company, it is the right moment to try their luck since they can buy it at a lower cost than what it is started. The analyst also has the same view based on the valuation of Facebook. Most analysts relate value to earning and as earning declines so does the value. The analyst’s estimates that reduction of the earning by 20% as it did in 2016 should result in a reduction in stock value by 30% (Cherney, 2016).
The risk-free rate is calculated by taking the current rate of inflation and subtract from the Treasury bond yield that matches specific fund yield. The reason for using Treasury bond yield as the basis for calculating risks free rate is because the government is less likely to default its debt obligation since it has many options on the table even in worst economic time. For instance, if they run out of money and the bonds are due, they can increase tax rates to raise the money. Therefore Treasury bond has full backing and faith from the government. Risk-free late can also be calculated using the CAPM model given the expected return, beta and risk premium for the stock.
E(Ri) = Rf + [E(RM) - Rf]Bi
E(Ri) - Rf = [E(RM) - Rf]Bi
E(Ri) - Rf = Bi .E(RM) - Bi. Rf
E(Ri) - Bi .E(RM) = Rf - Bi. Rf
Rf = (E(Ri) - Bi .E(RM))/(1-Bi.)
Since we have been given the market premium being 8, the risk-free rate can be expressed as follows.
E(Ri) = Rf + 8.Bi
Rf= E(Ri) – 8.Bi
Where
E(Ri) is expected a return on asset i
Rf is the risk-free rate
E(RM) is the expected market return on market portfolio
E(RM) - Rf is the market premium
WACC is a rate of return that tell what the debtholders and stockholders should expect. WACC can also be explained as an opportunity cost of taking the risks by putting the money on the company with the expectation of a better return in the future (MCCLURE, 2019). The lowest level WACC is favorable to the company future cash flow since the lower the WACC the higher the present value of future cash flows. WACC has many uses in investments today. For example, it is used as a discounting factor in calculating the net present value of an investment. WACC can also be used as a hurdle rate to assess ROIC performance. It is also essential in calculating the economic value added. Also, WACC is among the key factor to consider while evaluating an investment alternative since the company with low WACC are a potentially good investment opportunity.
company market value of equity market value of debt cost of equity cost of debt tax rate WACC Leverage
United states Steel (X) $ 6,244,480,000.00 $ 6,885,000.00 12.75% 3.47% 35% 12.74% 0.11%
Facebook (FB) $ 474,337,700,000.00 $ 5,767,000.00 30.51% 0.17% 35% 30.51% 0.00%
Therefore if Facebook and US Steel had an equal level of return let say 40%, US steel company would be the best value creator since for every dollar invested the company would return 27.26%. For Facebook at 40% return, the company only create the value of 9.49%.
Debt to equity ratio is a ration that is used to assess the company financial leverage. This ratio measures the company debt borrowing relative to its net asset. Therefore, it measures the extent to which the company is leveraging its assets through debts. A high debt to equity ratio is a risk indication meaning that the company has been taking loans aggressively to finance its growth. The outcome of taking more loan may not signify risks since if the earning due to debt exceed the interest payment extensively, then shareholder should be contented with their company financial structure. The worst thing about leverage is that unfavorable borrowing may not strike at first since it is directly affected by market conditions. Leverage ratio also has weaknesses, for instance, its effectiveness varies from industry to another. Each industry has a unique capital requirement as well as growth. Therefore, it is highly likely to find some industry with high debt to equity ratio while other industry having low (KENTON, 2019). For example, the iron and steel industry usually require heavy capital investment for equipment hence it is likely to have high debt to equity ratio. On the other hand internet service and social media industry usually, have low debt to equity ratio. The same applies in this case for US steel, the leverage is high above 0.11% while for Facebook is less at 0.0%. Therefore, these figures do not show that US steel has a risky capital structure and Facebook have a normal capital structure but it outlines industrial difference. The industrial average debt to equity ratio for iron and steel industry is 3%. It means that US steel is within the boundaries of industry and thus in a safe zone (Csimarket, 2019). For internet service and social media industry, the industrial average debt to equity ratio is usually close to zero. Therefore, Facebook is in a safe zone when leverage is concerned.
US Steel and Facebook are two different company operating in the different industry. Therefore, comparing their financial structure may not give a clear picture. Such a company can only be compared based on the industrial average. And checking the industrial average, both are operating well as they are within the averages in their industries.
References
Cherney, M. (2016). Facebook stock drops roughly 20%, loses $120 billion in value after warning that revenue growth will take a hit. Retrieved from https://www.marketwatch.com/story/facebook-stock-crushed-after-revenue-user-growth-miss-2018-07-25
Csimarket. (2019). Internet Services & Social Media Industry financial strength, leverage, interest, debt coverage and quick ratios. Retrieved from https://csimarket.com/Industry/industry_Financial_Strength_Ratios.php?ind=1005
KENTON, W. (2019). Debt/Equity Ratio. Retrieved from https://www.investopedia.com/terms/d/debtequityratio.asp
MCCLURE, B. (2019). Investors Need A Good WACC. Retrieved from https://www.investopedia.com/articles/fundamental/03/061103.asp
Yahoo. (2019). US steel and Facebook. Retrieved from https://finance.yahoo.com/quote/X/balance-sheet?p=X
Appendix
Cost of equity is calculated using the CAPM formula i.e. E (Ri) = Rf + [E(RM) - Rf]Bi. The WACC formula is given by;
WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-T)] where
E is market value of company equity
D market value of company debt
V total value of the company
Re is cost of equity
Rd cost of debt
T is tax rate
Leverage= total debt/ total equity
Market value of debt I m s given by
C[(1 – (1/((1 + Kd)^t)))/Kd] + [FV/((1 + Kd)^t)]
C is the interest expense
Kd is the cost of debt
T is the weighted average time to maturity
FV is future value or the total debt amount
