Reference no: EM132994645

1 Royal Mail plc: Cost of Capital (UK): 1.1 Brief Description of the Case

The case is about Royal Mail plc's senior financial analyst Hillary Hart, being tasked to evaluate the cost of capital for Royal Mail in July 2015. Cost of capital was used in capital budgeting, financial dictions, projection of future profitability and assessment of the performance of Royal Mail.

Royal Mail Plc is a provider of national postal service which was responsible for mail delivery and collection in the UK. It is an international business, developing an efficient, modern and optimized network to deliver new products, parcels, and letters. Due to the deregulation and privatization, the cost of capital became an issue within Royal Mail.

Since privatization in October 2013, Royal Mail had pivoted to a more market-based orientation. The cost of capital acted as a benchmark to assess the profitability of Royal Mail's operations and viability of its operations under existing regulatory policies. For 500 years, Royal Mail had served the diverse and changing needs of the customers by adapting, innovating and pioneering. Royal Mail continually transforms to further leverage these key strengths and had become the pre-eminent delivery company in its key markets or segments.

1.2 Key Issues to be Addressed

(a) The emerging issues were to evaluate the cost of capital for Royal Mail in the fiscal year 2015. Due to privatization, Royal Mail had shed its government-based policies for decision-making of the past for more market-based orientation. A cost of capital is not set by managers but by investors as a market-based measure. The government regulators, Royal Mail and Office of Communications (Ofcom) had been adjusting to privatize their ownership after 500 years from the ownership of government. In addition, the deregulation of the private postal service was common and highly experimental in the UK. As the competition was rigorous and intense, Ofcom was re-evaluating and reassessing the current regulatory policies.

(b) The weighted average cost of capital (WACC) is the most widely used concepts in finance. It is the minimum acceptable return rate that new investments should yield. Additionally, the cost of capital tends to represent the long-term fund's opportunity cost used by Royal Mail. In the case of management decision to make a considerable amount of investment in the project with the projected rate of returns above the weighted average cost of capital, the value of the company goes up. On the other hand, if the company invests in the project (with the probability of having the positive returns) with the projected returns below the weighted average cost of capital, the value of the company goes down.

(c) The cost of capital is required by investors and used by company's top management. Hence, estimating the cost of capital is extremely important when the company wants to know their return from the project investments.

(d) The main issue here is to ascertain on whether Kyle Brook's estimation on the cost of capital by looking at its cost of equity with the use of current dividend yield for the company and the cost of debt. To weigh the equity and debt, Brooks used book values instead of market value due to the fact that the top management was highly concerned with the estimation of how much it would cost to Royal Mail in order to raise capital.

Questions:

1) Help me understand Kyle Brooks estimate and what do you think of this analysis:

2) Have you estimated WACC of the comparable firms> Are the estimates of the WACC for comparable firms helpful to Hillary Hunt?