Long-Term Financial Planning
FedEx Corporation
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FedEx Corporation was established in 1971 and the company has four distinct business segments that include FedEx Express, FedEx Ground, FedEx Office and FedEx Freight. Over the years, the company has obtained 6-year of CAGR (compounded annual growth of 5%). However, the company is likely to obtain similar CAGR of 5.9% over the next 8 years based on current economic environment. (FedEx Corporation .2010.
The WACC (weighted average cost of capital) is the average interest rate that a company should pay in order to secure a project. Moreover, WACC is the average rate of return that a company must earn from its current assets to satisfy investors, shareholders and creditors. Since FedEx Corporation is always trying to create value for shareholders, the paper calculates the WACC of the FedEx to evaluate the company ability to generate returns from its assets.
Estimation of WACC of the Company
The WACC of the FedEx Corporation is calculated based on the estimation of the company-consolidated balance sheet of the year 2010 and the WACC is calculated using the table below:
Company name: FedEx Corporation
Table 1: Source of Finance ($millions)
Balance sheet value as of:__2010
Market value as of:_2010_
Proportion in total financing
Cost of capital
Product of (4)x (5)
(1)
(2)
(3)
(4)
(5)
(6)
Short-term debt
4,645
4,645
4,645
4,645
Long-term debt 1 Long-Term Debt, Less Current Portion
1,668
1,668
5%
83.4
Deferred income taxes
5%
44.6
Pension & post-retirement healthcare and other bene-t obligations
1,705
1,705
5%
85.25
Self-insurance accruals
5%
48
Deferred lease obligations
5%
40.2
Deferred gains to aircraft transactions
5%
13.35
Other liabilities
5%
7.55
Total other long-term liabilities
4,778
$6,725.04
4,778
5%
Preferred shares
Common equity
Total (Outstanding Shares
312 million
$43,087.2
1.000
6%
$2,585.23
As being revealed in Table 1, the short-term debt of FedEx Corporation is approximately $4,645 Million. The paper estimates that the market value of the company short-term debt is equal to the book value. Based on this estimation, the market value of the company short-term debt is $4,645 Million.
However, estimation of the company market value for the company long-term debts is different from the estimation of the short-term debt. As being revealed in the FedEx Corporation consolidated balance sheet 2010, the FedEx long-term debts are not traded. To calculate the market value of the company long-term debts, the paper considers what the potential lenders require at present as a reasonable yield to maturity. The paper assumes that the yield of the company short-term debts is zero. However, the yield of the company long-term debts should be reasonably above the yields of the government bonds and notes. The present yields of government bonds and notes are 3.38%, and given the status and business position of FedEx Corporation, the required yield to maturity will be reasonably above the yield of the government bonds. The report assumes that the yield of the FedEx long-term debt will be 5%.
As being recorded in the 2010 consolidated balance sheet, the company total long — term debts are $4,778 Million carrying the interest of 5% per year and the paper estimates the maturity of these debts to be 6 years.
To calculate the market value of the company long-term debts using the required yield of 5%, the market value of the company long-term debts would be equal to the present value of the cash flow, and discounted at 5% will be as follows:
Table 1: Source of Finance ($millions)
Balance sheet value as of:__2010
Market value as of:_2010_
(1)
(2)
(3)
Short-term debt
4,645
4,645
Long-term debt 1 Long-Term Debt, Less Current Portion
1,668
Deferred income taxes
Pension & post-retirement healthcare and other bene-t obligations
1,705
Self-insurance accruals
Deferred lease obligations
Deferred gains to aircraft transactions
Other liabilities
Total other long-term liabilities
4,778
$6,725.04
Preferred shares
Common equity
Total (Outstanding Shares
312 million
$43,087.2
The company market value for the company long-term debts is $6,725.04 Million.
Equity
The market value of the equity of the FedEx is calculated by multiplying the company common outstanding shares by today’s market price per share. In May 31, 2010, the company issued 312 million common outstanding shares, and today price of the company outstanding shares is $138.10.
Thu, the market value of the company of the equity is as follows:
V=312 million x 138.10.
V=$43,087.2 Million
The paper assumes that 6% is the yield of the company outstanding shares. Thus, the cost of equity is 6% x $43,087.2 Million
Cost of Equity =$2,585.23 Million.
The report now calculates the WACC using the following formula:
WACC = “(E/V) X Re + (D/V) X Rd X (1 — Tc)”
Where:
Re = Cost of equity
Rd = Cost of debt
E = “Market value of the firm’s equity”
D = “Market value of the firm’s debt”
V = E + D
E/V = “Percentage of financing that is equity”
D/V = “Percentage of financing that is debt”
TC = Corporate tax rate
WACC = 0.6 x 0.6 + (0.5 x 0.6 x 0.65)
WACC =0.555 or 5.55%
Based on the calculation presented above the company WACC is 5.55%.
Part II
The first step is to calculate the depreciation of the machines using the following formula:
Straight line depreciation=” (Purchase price of asset — Approximate salvage value) / Estimated useful life of asset”
Straight line depreciation
Purchase price of asset
Approximate salvage value
Estimated useful life of asset
Depreciation
Equipment 1
$8,000,000
$3,000,000
6 years
$833,333
Equipment 2
$8,000,000
$3,000,000
6 years
$833,333
Equipment 3
$4,000,000
$1,000,000
6 years
$500,000
The paper computes the tax cash flow first before computing the future cash flow.
Tax Cash flow ($000)
Year
Investment in Machinery and equipment
Purchase of office supplies
Direct and indirect labor
Marketing expenses
Revenues
Depreciation
Taxable Income
Tax
0
8,000(1)
0
0
-400
0
1
8,000(2)
-20
-4,800
-800
8,000
-$361.10
2,019
-524.9
2
4,000(3)
-10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
3
0
-10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
4
0
-10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
5
0
10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
6
0
-10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
Future Cash flow of the company investment ($000)
Year
Investment in Machinery and equipment
Purchase of office supplies
Direct and indirect labor
Marketing expenses
Revenues
Depreciation
Taxable Income
Tax
Cost of Machine
Savage Value
Future Cash Flow
0
8,000(1)
0
0
-400
0
-20,000
-20400
1
8,000(2)
-20
-4,800
-800
8,000
-$361.10
2,019
-524.9
2
4,000(3)
-10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
11029.76
3
0
-10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
11029.76
4
0
-10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
11029.76
5
0
10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
11029.76
6
0
-10
-5,600
-690
13,000
-$361.10
6,339
-1648.14
7,000
18029.76
In the light of the inflation on the coming year, there is a need to make adjust on the cash flow. The inflation may increase the price of the expenses, and based on the projected increase in the inflation, the expenses can go up and decrease the future cash flow of the investment. Thus, the paper suggests that the expenses could increase by 3% making the cash flow to decline by 3%.
c. Net Present Value
The paper uses the Excel software to calculate the NPV and the results of the NPV are as follows:
Net Present Value ($000)
Discount Rate
6%
Life of Project
6 Years
Initial Cost:
$20,000
Cash flow Year 0
-20400
Cash flow Year 1
Cash flow Year 2
11029.76
Cash flow Year 3
11029.76
Cash flow Year 4
11029.76
Cash flow Year 5
11029.76
Cash flow Year 6
18029.76
NPV: $9,887.14
Memo
To: FedEx Corporation
This report recommends that you should pursue the project because the projected cash flows of the project are $29.88 Million, which is greater than $20 Million invested in the project. Thus, pursuing the project will be optimal for your company.
Reference
FedEx Corporation (2010. Annual Report.USA.
