In Activity 6.2.4 you were exposed to the Cost of Capital by Sector (Links to an
ID: 2750450 • Letter: I
Question
In Activity 6.2.4 you were exposed to the Cost of Capital by Sector (Links to an external site.). One of the columns provides the percentage of debt financing by industry (D/(D+E)). There are several industries with low percentages of debt financing. Take a look and identify some with a low percentage of debt financing and do the same with firms that have a high percentage of debt financing (the average according to the data in the link is about 42 percent).
Note: Do not use the banking financial services industries.
Based on the types of firms that use a small amount of debt and those that use higher amounts of debt, what can you conclude? What is it about the firms that use low amounts of debt? More debt would lower their cost of capital so what is holding these firms back form taking on more debt? You need to think a little, do not simply say the firms with low debt are all in industry x or industries similar to x. That is obvious, what is the economic intuition? What is the story?
Date updated: 05-1-15 Created by: Aswath Damodaran, adamodar@stern.nyu.edu What is this data? Cost of equity and capital (updateable) US companies Home Page: http://www.damodaran.com Data website: http://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html Companies in each industry: http://www.stern.nyu.edu/~adamodar/pc/datasets/indname.xls Variable definitions: http://www.stern.nyu.edu/~adamodar/New_Home_Page/datafile/variable.htm To update this spreadsheet, enter the following Cost of Debt Lookup Table (based on std dev in stock prices) Long Term Treasury bond rate = 2.17% Standard Deviation Basis Spread Risk Premium to Use for Equity = 5.75% Global weighted average 0 0.25 0.50% Global Default Spread to add to cost of debt = 0.00% Global weighted average 0.25 0.5 1.00% Do you want to use the marginal tax rate for cost of debt? Yes 0.5 0.65 1.50% If yes, enter the marginal tax rate to use 40% 0.65 0.8 2.00% 0.8 0.9 2.50% 0.9 1 3.00% 1 10 4.00% Industry Name Number of Firms Beta Cost of Equity E/(D+E) Std Dev in Stock Cost of Debt Tax Rate After-tax Cost of Debt D/(D+E) Cost of Capital Advertising 52 1.18 8.96% 66.39% 51.52% 3.67% 4.13% 2.20% 33.61% 6.69% Aerospace/Defense 93 1.16 8.84% 84.07% 50.15% 3.67% 14.87% 2.20% 15.93% 7.78% Air Transport 22 0.98 7.80% 55.09% 53.32% 3.67% 18.71% 2.20% 44.91% 5.28% Apparel 64 0.99 7.88% 82.83% 56.24% 3.67% 11.16% 2.20% 17.17% 6.90% Auto & Truck 22 1.09 8.47% 48.56% 43.52% 3.17% 4.45% 1.90% 51.44% 5.09% Auto Parts 75 1.35 9.92% 77.73% 53.89% 3.67% 11.05% 2.20% 22.27% 8.20% Bank (Money Center) 13 0.81 6.81% 31.38% 39.98% 3.17% 26.43% 1.90% 68.62% 3.44% Banks (Regional) 676 0.53 5.20% 56.28% 37.41% 3.17% 20.66% 1.90% 43.72% 3.76% Beverage (Alcoholic) 22 1.06 8.24% 82.05% 55.14% 3.67% 8.54% 2.20% 17.95% 7.16% Beverage (Soft) 46 1.14 8.71% 81.27% 61.94% 3.67% 5.55% 2.20% 18.73% 7.49% Broadcasting 28 1.30 9.62% 58.46% 62.12% 3.67% 18.34% 2.20% 41.54% 6.54% Brokerage & Investment Banking 46 1.16 8.84% 24.78% 44.77% 3.17% 13.99% 1.90% 75.22% 3.62% Building Materials 39 1.12 8.59% 75.62% 43.52% 3.17% 17.45% 1.90% 24.38% 6.96% Business & Consumer Services 177 1.19 9.03% 76.68% 52.77% 3.67% 13.30% 2.20% 23.32% 7.44% Cable TV 18 0.91 7.42% 69.06% 52.83% 3.67% 21.18% 2.20% 30.94% 5.81% Chemical (Basic) 46 0.94 7.55% 71.27% 50.32% 3.67% 10.88% 2.20% 28.73% 6.01% Chemical (Diversified) 10 1.17 8.91% 75.08% 41.14% 3.17% 22.47% 1.90% 24.92% 7.17% Chemical (Specialty) 103 1.03 8.07% 82.40% 51.80% 3.67% 11.16% 2.20% 17.60% 7.04% Coal & Related Energy 42 1.64 11.61% 47.53% 74.62% 4.17% 0.99% 2.50% 52.47% 6.83% Computer Services 119 1.16 8.84% 78.39% 59.41% 3.67% 10.48% 2.20% 21.61% 7.40% Computers/Peripherals 64 1.21 9.13% 91.35% 66.35% 4.17% 7.35% 2.50% 8.65% 8.56% Construction Supplies 55 1.60 11.37% 68.78% 47.26% 3.17% 16.28% 1.90% 31.22% 8.42% Diversified 23 1.00 7.91% 62.16% 32.85% 3.17% 13.96% 1.90% 37.84% 5.64% Drugs (Biotechnology) 400 1.10 8.52% 92.18% 93.06% 5.17% 1.48% 3.10% 7.82% 8.10% Drugs (Pharmaceutical) 151 1.03 8.08% 88.17% 75.04% 4.17% 4.58% 2.50% 11.83% 7.42% Education 42 1.13 8.65% 71.72% 70.19% 4.17% 12.18% 2.50% 28.28% 6.91% Electrical Equipment 126 1.24 9.29% 85.57% 65.34% 4.17% 5.99% 2.50% 14.43% 8.31% Electronics (Consumer & Office) 28 1.37 10.06% 95.76% 56.16% 3.67% 4.50% 2.20% 4.24% 9.73% Electronics (General) 189 1.03 8.08% 87.19% 69.01% 4.17% 8.64% 2.50% 12.81% 7.37% Engineering/Construction 56 1.31 9.69% 78.55% 47.91% 3.17% 14.18% 1.90% 21.45% 8.02% Entertainment 84 1.21 9.10% 78.42% 58.48% 3.67% 4.11% 2.20% 21.58% 7.61% Environmental & Waste Services 103 1.28 9.56% 71.14% 65.61% 4.17% 6.31% 2.50% 28.86% 7.52% Farming/Agriculture 37 0.84 7.02% 62.32% 41.59% 3.17% 9.36% 1.90% 37.68% 5.09% Financial Svcs. (Non-bank & Insurance) 288 0.67 6.01% 7.65% 38.80% 3.17% 18.49% 1.90% 92.35% 2.22% Food Processing 96 0.99 7.88% 78.61% 42.05% 3.17% 13.70% 1.90% 21.39% 6.60% Food Wholesalers 14 1.41 10.29% 85.40% 35.73% 3.17% 13.47% 1.90% 14.60% 9.07% Furn/Home Furnishings 27 1.09 8.44% 78.98% 54.24% 3.67% 14.48% 2.20% 21.02% 7.13% Green & Renewable Energy 26 1.32 9.76% 47.63% 53.18% 3.67% 1.94% 2.20% 52.37% 5.80% Healthcare Products 261 0.99 7.86% 86.46% 64.48% 3.67% 6.73% 2.20% 13.54% 7.09% Healthcare Support Services 138 1.05 8.23% 78.95% 46.72% 3.17% 13.27% 1.90% 21.05% 6.90% Heathcare Information and Technology 127 0.95 7.63% 83.51% 70.49% 4.17% 6.35% 2.50% 16.49% 6.79% Homebuilding 35 1.29 9.57% 62.20% 53.78% 3.67% 18.11% 2.20% 37.80% 6.78% Hospitals/Healthcare Facilities 56 0.97 7.76% 56.95% 43.11% 3.17% 10.93% 1.90% 43.05% 5.24% Hotel/Gaming 80 1.18 8.96% 64.67% 49.55% 3.17% 11.41% 1.90% 35.33% 6.47% Household Products 135 1.03 8.08% 84.11% 61.63% 3.67% 10.46% 2.20% 15.89% 7.15% Information Services 67 1.11 8.58% 88.25% 42.71% 3.17% 17.93% 1.90% 11.75% 7.80% Insurance (General) 24 1.03 8.09% 69.91% 35.35% 3.17% 19.21% 1.90% 30.09% 6.23% Insurance (Life) 25 1.04 8.16% 58.40% 34.48% 3.17% 24.30% 1.90% 41.60% 5.56% Insurance (Prop/Cas.) 52 0.83 6.94% 75.24% 36.73% 3.17% 22.18% 1.90% 24.76% 5.69% Investments & Asset Management 148 1.10 8.48% 57.45% 41.63% 3.17% 6.84% 1.90% 42.55% 5.68% Machinery 137 1.23 9.22% 83.03% 46.22% 3.17% 15.64% 1.90% 16.97% 7.98% Metals & Mining 124 1.28 9.54% 66.36% 74.49% 4.17% 1.80% 2.50% 33.64% 7.17% Office Equipment & Services 25 1.34 9.89% 65.84% 49.87% 3.17% 18.65% 1.90% 34.16% 7.16% Oil/Gas (Integrated) 8 0.81 6.81% 90.04% 33.56% 3.17% 14.56% 1.90% 9.96% 6.33% Oil/Gas (Production and Exploration) 392 1.27 9.45% 67.49% 71.93% 4.17% 7.04% 2.50% 32.51% 7.19% Oil/Gas Distribution 85 0.96 7.71% 67.68% 43.15% 3.17% 4.68% 1.90% 32.32% 5.84% Oilfield Svcs/Equip. 161 1.54 11.04% 78.35% 65.23% 4.17% 10.99% 2.50% 21.65% 9.19% Packaging & Container 26 0.95 7.62% 67.30% 31.06% 3.17% 18.18% 1.90% 32.70% 5.75% Paper/Forest Products 22 0.84 6.97% 66.22% 44.94% 3.17% 11.54% 1.90% 33.78% 5.26% Power 82 0.83 6.94% 56.90% 29.70% 3.17% 20.77% 1.90% 43.10% 4.77% Precious Metals 147 1.29 9.61% 71.02% 93.69% 5.17% 1.33% 3.10% 28.98% 7.72% Publshing & Newspapers 43 1.15 8.77% 67.85% 50.42% 3.67% 14.93% 2.20% 32.15% 6.66% R.E.I.T. 213 0.79 6.69% 53.05% 31.55% 3.17% 1.24% 1.90% 46.95% 4.44% Real Estate (Development) 18 1.02 8.04% 68.77% 43.65% 3.17% 7.21% 1.90% 31.23% 6.13% Real Estate (General/Diversified) 11 1.82 12.63% 78.39% 45.97% 3.17% 9.39% 1.90% 21.61% 10.31% Real Estate (Operations & Services) 52 1.30 9.66% 63.56% 50.05% 3.67% 8.63% 2.20% 36.44% 6.94% Recreation 68 1.21 9.14% 75.97% 50.41% 3.67% 11.25% 2.20% 24.03% 7.47% Reinsurance 4 1.35 9.91% 72.68% 21.20% 2.67% 15.53% 1.60% 27.32% 7.64% Restaurant/Dining 79 0.89 7.30% 78.20% 44.43% 3.17% 15.14% 1.90% 21.80% 6.13% Retail (Automotive) 30 1.18 8.93% 66.58% 48.06% 3.17% 18.76% 1.90% 33.42% 6.58% Retail (Building Supply) 5 1.44 10.46% 83.71% 50.71% 3.67% 30.64% 2.20% 16.29% 9.12% Retail (Distributors) 90 1.12 8.58% 67.57% 52.06% 3.67% 16.84% 2.20% 32.43% 6.51% Retail (General) 23 1.03 8.10% 76.12% 46.36% 3.17% 21.36% 1.90% 23.88% 6.62% Retail (Grocery and Food) 21 1.05 8.20% 64.05% 51.83% 3.67% 22.94% 2.20% 35.95% 6.04% Retail (Online) 46 1.40 10.19% 93.01% 70.16% 4.17% 9.38% 2.50% 6.99% 9.65% Retail (Special Lines) 128 1.07 8.35% 70.70% 51.42% 3.67% 20.44% 2.20% 29.30% 6.55% Rubber& Tires 4 1.02 8.04% 53.26% 49.54% 3.17% 13.58% 1.90% 46.74% 5.17% Semiconductor 100 1.21 9.15% 90.29% 57.12% 3.67% 10.11% 2.20% 9.71% 8.48% Semiconductor Equip 47 1.23 9.26% 85.01% 60.18% 3.67% 6.88% 2.20% 14.99% 8.20% Shipbuilding & Marine 14 1.36 10.00% 65.10% 71.45% 4.17% 6.75% 2.50% 34.90% 7.38% Shoe 13 0.84 7.01% 93.16% 40.80% 3.17% 20.15% 1.90% 6.84% 6.66% Software (Entertainment) 20 1.12 8.58% 85.25% 69.84% 4.17% 1.46% 2.50% 14.75% 7.68% Software (Internet) 327 1.29 9.57% 94.71% 72.48% 4.17% 5.07% 2.50% 5.29% 9.19% Software (System & Application) 259 1.10 8.52% 91.16% 61.85% 3.67% 6.86% 2.20% 8.84% 7.96% Steel 40 1.31 9.72% 60.96% 52.45% 3.67% 13.99% 2.20% 39.04% 6.78% Telecom (Wireless) 21 1.15 8.78% 39.31% 53.05% 3.67% 5.76% 2.20% 60.69% 4.79% Telecom. Equipment 126 1.24 9.32% 89.51% 62.74% 3.67% 8.70% 2.20% 10.49% 8.57% Telecom. Services 77 1.07 8.31% 60.45% 55.60% 3.67% 11.83% 2.20% 39.55% 5.90% Tobacco 20 1.09 8.41% 83.51% 41.74% 3.17% 12.39% 1.90% 16.49% 7.34% Transportation 21 0.86 7.10% 82.62% 42.36% 3.17% 20.08% 1.90% 17.38% 6.20% Transportation (Railroads) 10 1.05 8.19% 83.19% 30.73% 3.17% 21.30% 1.90% 16.81% 7.14% Trucking 30 1.32 9.78% 60.00% 48.49% 3.17% 27.38% 1.90% 40.00% 6.63% Unclassified 8 0.10 2.77% 79.20% NA #N/A 3.93% #N/A 20.80% #N/A Utility (General) 21 0.59 5.58% 62.00% 23.02% 2.67% 30.59% 1.60% 38.00% 4.07% Utility (Water) 19 1.09 8.41% 66.59% 38.21% 3.17% 15.10% 1.90% 33.41% 6.24% Total Market 7887 1.06 8.29% 60.19% 53.60% 3.67% 10.76% 2.20% 39.81% 5.87%Explanation / Answer
the percentage of debt financing by industry (D/(D+E)), some of the industries with low percentages of debt financing (D/(D+E)) in table are Electronics (Consumer & Office)(D/(D+E)=4.24%),Oil/Gas (Integrated)(9.96%),Retail (Online)(6.99%),Software (Internet)(5.29%).
some of the industries with high percentages of debt financing (D/(D+E)) in table are Telecom (Wireless)(60.69%),Green & Renewable Energy(52.37%),Financial Svcs. (Non-bank & Insurance)(92.35%).
The firms that use a small amount of debt as Software (Internet) where usually the capital is raised mainly from equity and very less from the debt markets,the investment acquired in this firms from debt is very low.The internet firms could raise majority of financing required internally because of the large cash they sit on so there is no requirement to raise from debt market,also pecking order theory supports this that firm always prefer to raise capital internally to lower overall cost of capital for the firm.The firms that use a larger amount of debt are one that require a lot of amount of investment like in Financial Svcs. and Green & Renewable Energy where a large amount of debt are used to fund the investment.In Financial Svcs. the debt is used to leverage returns whereas the same debt is used to fund various investments in Green & Renewable Energy industry.The amount of cash is not enough to raise funds internally therefore these high %Debt firms turns to Debt markets to raise additional funds.