Introduction
Harman International industries Ltd is situated in America, in the New York City. It trades its securities though New York Stock Exchange. The company produces and sells audio, electronic, and infotainment systems mostly used by automotive manufacturers. The company offers a variety of brands including JBL, Infinity, Lexicon, and Logic 7 among others which are used as trade names in trading the products of the company. Most of the products are sold in the local market but there are also international consumers, mostly for audio and electronics product groups. The company has its headquarters in Stanford but also has branches in Europe and Asia. The purposes of this study is to estimate and provide an analysis of the cost of equity, the cost of capital, investment returns, and the optimal cost of capital of Harman International industries. We shall use the data for 2010 and 2011 to compute the ratios and figured required in this analysis.
The cost of equity
The cost of Equity of a firm basically defines the rate of return that the shareholders expect to obtain from their investment in in shares. It is the rate that makes a company woos an investor to make equity investment. It is a measure of what the firm pays to its investors (equity investors) for the amounts they have put in the firm as investment. The higher the cost of equity, the better the firm and the higher the shareholders return. The ratio is given by the sum of dividend per share and increase in market price per share. For this company, the Dividend per share for 2011 was $0.2. The Market price per share was $46.30 in 2010 and $38.04 in 2011. The cost of equity is computed as follows:
Cost of equity = {0.2 + (46.30-38.04)}/46.30*100 = 18.27%. This approach is called dividend growth approach. The ratio of 18.27% shows what the firm will be paying its equity shareholders for their investment. They will get 18.27% on their investment as returns.
The cost of capital
He cost of capital defines the cost of acquiring a company’s funds, both debt and equity capital. It may also be used to compare a number of projects with an aim of selecting the best to undertake. It is the cost that would have been incurred if the money was not invested in the said project, normally referred to as the opportunity cost of undertaking an investment. We normally use Weighted Average Cost of Capital (WACC) to assess the level of cost of capital of a firm or an investment.
It is computed as follows.
WACC(ko) = kd( D ) + kp ( P ) + kr ( R ) + ks ( S )
V V V V
Where;
kd, kp, kr, ks =percentage cost of debt, preference share capital, retained earnings and external equity respectively
D, P, R, S = total debt, preference, retained and ordinary share capital respectively
V = total value/capital of the firm
Hence, D, P, R, S
V V V V are the proportions of weights of debt, preference capital, retained earnings and external equity in the capital structure respectively.
For the company in question, for year 2011, the total capital is $3,058,495.
Kd =0.05, Kr = 0.03, and Ks = 0.25.
Thus, WACC = WACC (ko) = 0.05(1,634,837/$3,058,495. ) + 0.03 (1,418,106/$3,058,495) + 0.2 (1,423,658/3,058,495) = 0.0267 + 0.139 + 0.0931 = 0.26.
Investment returns
Investment return is a ratio, also referred to as return on investment. It is used to measure the efficiency of an investment of a firm. It also helps an investor assess the efficiency of several investment projects and to select the best to undertake. It measures the return on profit from a given investment. It is computed as follows:
Investment returns = Net profit x 100
Total assets
For the year 2011, investment return for Harman International industries is as follows:
Investment returns = {$135916/ $3,058,495}*100 = 4.44%. This shows that 4.44% of the profit generated in 2011 was obtained from the utilization of total assets. The higher the ratio, the better is the firm and vice versa.
The optimal cost of capital
This is the cost of capital that balance ensures there is a balance between the debt to equity ratio and the cost of capital of a firm. A higher debt to equity ratio means that there is a high cost of capital. The investors should therefore always ensure that the debt to equity ratio low for a company to remain relevant to the equity shareholders. If we consider the debt ratio of (1,634,837/$3,058,495) = 0.5345 = 53.45%, it means that the cost of capital will not be very favorable, although sound, because much of the assets of the company are financed by debt. 46.55% of equity ratio means the portion of the total assets of the company that the equity investors can claim from the firm.
