605 Words3 Pages

Delta Airline’s Cost of Capital
A Case Study
Part I:
Compute Cost of Debt/Cost of Equity/ WACC
• The beta of the stock is 0.90, based upon a regression of Delta stock returns against the S&P 500 Index.
• The share price is $27.70, and there are 850,902,527 shares outstanding. Delta’s market cap is 23.57 billion.
• The firm has $11,082 million in long-term debt on its balance sheet. Delta incurs a marginal corporate tax rate of 30%.
• 20 year Treasury risk free rate is currently about 3.64%. The historical (1926-2008) difference in yield between 20-year government bonds and T-bills is around 2.3%. Subtract 2.3% from the 20-year rate to find the equivalent average one-year interest rate today. The one-year risk free interest rate is 1.34%.
• Use the historical market risk premium of 7.5%.
a. Estimate the cost of equity for Delta.
By using the CAPM model, the cost of equity is:
(1.34% + 0.9(7.5% - 1.34%)) = 6.90%
b. Estimate the cost of Debt for Delta.
The after-tax cost of debt is: Rate(1-Taxrate) = 3.64%(1 -.30) = 2.55%
The market value of equity is price*shares = $27.70*850,902,527.
The sum of these is $23.57 billion, which is also the market cap.
The long term debt is $11,082 million.
c. Calculate the weighted average cost of capital (WACC) for Delta.
Using a WACC calculator from www.miniwebtool.com, the calculated WACC is 6.90%.
This is the minimum acceptable return rate that the company must pay to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Delta has a high cost of equity ratio compared to its long term debt cost ratio. This is mainly because Delta has over 850 million shares of stock outstanding.
Part II:
Compute payback/NPV/IRR/MIRR
Evaluate profitability of proposed new project and make recommendations
The projected cash flows for the new route are as follows 1/:
Year

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