Microsoft: Company Overview, WACC, Cost Of Capital & Financial Essay.

Discuss about the Case Study Of Microsoft.

In this assignment cover following point:

1. Background of Microsoft
2. What is WACC
3. Total Market Value of Equity
4. Total Market Value of Debt
5. Total Market Value 3
6. Cost of Equity
7. Cost of debt
8. Gearing ratio analysis

Microsoft's Products and Partnerships

Microsoft is a renowned multinational innovation-based company. Headquarter of this organization is established in Washington, United States. This company was incorporated in 4^th April 1975. It was founded by Paul Allen and bill Gates. Some of the best-selling products of this company includes Windows operating system, MS- office suite of productivity software, a series of entertainment games, video, music, and a chain of search engines.      

Microsoft affiliated with IBM in 1980 to enable different programs on Microsoft`s computer system which was combined with computing devices that provides a royalty for each sales agreement. According to IBM, Microsoft produces edge-cutting computer system for IBM`s computing devices known as OS/2. Microsoft has created a computer system but on the same side it keep promoting their own computer systems that groomed out to be in straight wiring competition with the Microsoft`s OS/2. At some point of time, Microsoft dominated the market through OS/2 when it comes to sell the products. At the time, when Microsoft launched a wide variety of Microsoft windows versions in 1990 and they were recorded for more than 90 percent of stock market share in the world`s computers.

During 30 June 2015, the company has attained a worldwide sale of $86.83 billion each year as well as 128,076 workforce all over the globe. The company undertakes to develop, license, and produce and support a wide variety of software programs for computer.

WACC (weighted average cost of capital) is average rate of interest in terms of investment return, which an organisation plans to pay each individual shareholder. The weight is the rate at which the company is expected to pay on average of all the security holders to sponsor the assets. It is an average cost of raising money from each available resource. The weight signifies the amount of each financing method in the company`s final equity configuration. It is important and mandatory to measure and analyse the weighted average (cost of capital) with an aim to assess the budget of total and long run investments. Lesser is the company`s WACC, the necessity for financing through new other innovative activities is less.      

In order to incur less cost, an organisation look for other methods to reduce their WACC. This implies that company can make use of less costly resources. For example- Organisation “X” may probably distribute bonds rather than stock because it will incur less finance cost. This will also improve debt-equity proportion in the capital structure of the company because debt will cost less than equity. Ultimately, the company’s cost of capital will be reduced.

History of Microsoft and IBM Affiliation

WACC= (E/V) * R_E + (D/V) * (R_d)*(1-T_c)

Wherein-

Items	Full forms
RD	Cost of debt
Tc	Corporate tax rate
E	Total market value of the company’s equity
V	Total market value of the company (E+D)
RE	Cost of equity
D	Total market value of the company’s debt

Total equity of Microsoft: 74,810 million United States dollar

 

Microsoft’s total market value: Total equity + total debt = 74,810 million + 86,194 million = 161,004million United States dollar

Cost of equity of Microsoft-

=R_f + β (R_m-R_f)

=2.06% + 1.44 * 6% = 10.7%

Cost of debt of Microsoft-

= (Interest expense/ Total debt)

= 2222/69827.5 = 3.18%

Tax rate in US is 40 %

Weighted average cost of capital of Microsoft

= (74810/161004) * 10.7 + (86194/161004) * 3.18 * (1-0.4)

=5.993%

Market value of equity (E)

Market value is the total worth amount of either company`s outstanding shares or stock calculation-based on their market prices. In addition to this, it is total price of entire outstanding stock measured according to fluctuation in stock exchange`s prices. On the basis of Microsoft, total shareholder`s equity in 2017 was around 74,810 million dollars in US Dollar. This is calculated by totalling all the total equity shares, which has been given to the shareholders of parent company consisting of several factors such as treasury factors, retain earnings, other reserves, translation reserves, and share capital together with non-controlling interests.

Market value of debt is calculated by adding the company`s short-term loan, current share long-term and short-term debt and non-current share of long-term debt in total capital. Short-term debt discloses current debt portion in the company`s balance sheet. This record have every debt charged by the company, which is currently due within a time period of twelve months. Financial debt consists of short-term bank loans taken by the company among other types. The quantity of principal amount, which is the current portion long-term debt, will be owned within 12 months. On the other hand, long-term debt also has non-current portion of financial obligations that last after one year. Long-term debt of an organisation that includes either any loan or other leasing obligation are supposed to be owned in more than 1 year.  According to net stock analysis, total financial debt of Microsoft is around 86,194 million in US$ by summing up the all debt liabilities are-

This amount is calculated by totalling the whole debt and equity. The total market value of borrowed fund of Microsoft is given below-

Cost of equity is the return, which shareholders need to invest in the shares of the company. To calculate cost of equity, two methods to assess the cost of equity are as follows-

Financial Standing of Microsoft

Dividend growth model

This model is suitable only if currently the organisation is paying dividend at rational constant rate. The formula for the model is given below-

RE= (D1/P0) + g

Wherein,

Items	Full form
P0	Current share price
D1	Expected dividend in a single period
g	dividend growth rate

This method undertakes to show a connection between the organised risk and the estimated return for assets especially shares and stocks. This model is popularly used in finance firstly for pricing the risky securities, generating the returns for the property at the given percentage of risk and ultimately calculating the capital expenditure. The formula is given below-

RE= RF + βE (E (RM) – RF)

Wherein-

Items	Interpretation
RE	Cost of equity
βE	Beta of Asset
RF	Risk-free rate
E(RM) – RF	Market premium

In order to calculate the CAPM (Capital Asset Pricing model) of Microsoft, certain values are needed and are given below-    

Items	Interpretation
Risk-free rate	2.06%
Market premium	6%
Beta of Asset	1.44%

Cost of Equity = 2.06% + 1.44 * 6% = 10.7% (Gurufocus, 2017)       

Cost of debt is an efficient rate, when a company financially pays on the current debt and loans. In order to calculate the company`s cost of debt, it needs to search the sum of interest that the company used to settle its both long-term and short-term debts in a year. To calculate cost of debt, given below is the formula-     

(Interest expense/Total debt) (Investopedia, 2017)

Microsoft’s cost of debt = 2222/69827.5 = 3.18% (Gurufocus, 2017)

It is seen that the cost of debt is around 3.18 percent which means that for a single dollar that investors have lend to the company (Microsoft), they need a return of around 3.18 percent. Cost of debt is lower than the cost of equity because of some reasons, here are given below-

Tax and Interest deduction- This factor signifies the importance of issuing bonds that would led to assess the interest cost of the bond. A company can reduce its considerable or measurable pay after issuing the bonds but when profit is paid to the investors then they are not tax deductable. On the other hand, organisation can issue the securities at low loan fees.       

Ownership protection- By issuing bonds, the possession rate in the company does not change whereas offering the stock can weaken the ownership rate. This is based on the grounds that investors are recognised as one and can outvote if any issues occur but bondholders only ask for the financial experts to know the advancement of cash payment.   

Fixed maturity date- Shares have lifelong expectancy whereas bonds have only limited life expectancy. Maturity date implies that bonds have a development date to pay the periodical intrigue and paying the first credit. At the other time, the company should offer generous premium for the speculators that convince them to offer its offering again that can be kept as everlasting originally when the share is issued to these investors.  

Understanding WACC (Weighted Average Cost of Capital)

Callable feature- This feature means the ability of bond issuers to redeem their bond before the real development date. When the fees of rendering loans fall, company starts offering new securities by ignoring the priority of old securities because the company can offer the new securities at low financing cost. The cancelled securities are returned back at their face values and company quit the accrual loan fees as of callable date. When organisation is able enough to pay profits to its investors. Moreover, if the company fails to pay on its instalments then a investor can record a claim against the company.      

This ratio measures how the company is able to finance its regular operations in a mixture of proprietor assets that is borrowed assets (obligation). Companies who have high gearing ratios are most probably influenced by the monetary recessions. It is related to organisation`s high use which will have high measure of obligation while contrasting to the value. In every case, when the gearing ratio is high they every time do not really and imply that they are poor conditions rather than having a less secure monetary structure as compared to the company who have less gearing ratio.

The gearing ratios of Microsoft are given below:

Gearing ratio	Formula	Calculation	Result
Leverage ratio	Total debt/Total equity	86,194/ 74,810	1.152
Debt ratio	Total debt/ Total assets	86,194/ 193690	0.445
Equity ratio	Total equity/Total assets	74,810/ 193690	0.386

 
According to the calculations done, the leverage ratio is 1.152 which means that for every dollar of shareholder`s equity, the company has 1.152 cents for debt. Whereas, debt-equity ratio is more prominent even more than 2, which shows dangerous situation for the speculators which can bring unpredictable profit due to costs of extra premium which have emerged by issuing more debt where it was high even before, which calls for a situation of liquidation of the company. Microsoft`s esteem of its equity shareholders is more noteworthy than the debt which suggests that the leverage ratio is dangerous and its capital structure is contributing high rate of returns. General debt ratio 0.445 implies that the company is dependent on tons of debt, and its advantage is not at all less than 2 times (aggregate debt esteem). Moreover, general equity of around 0.386 implies that there is an substantial extent of Microsoft`s returns are financed by issuing shares. The calculation and its interpretation recommends that the company have enough money for the future item developments and their openings.

The current rate of Microsoft is 5.993% and a gearing ratio of 1.152. For best administration, the company has to boost the investor. It is prescribed that the increment of WACC rate lower down the obligation fund and expand the value by 20000 million USD. This is based on such grounds that company` measure of obligation is rising on the chance that it has not been stopped even at that point that will ultimately fear the defaulting obligation. By applying this method, WACC rate will be as follows-

Items	Amount
Microsoft’s new total equity	74,810 million + 20,000 million = 94,810 million
Microsoft’s new total debt	86,194 million – 20,000 million = 66,194 million
Microsoft’s new total market value	94,810 million + 66,194 million=161,004 million
Microsoft’s new cost of equity (Rf + β (Rm-Rf))	2.06% + 1.44 * 6% = 10.7%
Microsoft’s new cost of debt (Interest expense/ Total debt)	2222/69827.5 = 3.18%

Tax rate in US= 40 %

Current WACC of Microsoft-

(94,810/161,004) * 10.7 + (66,194/161,004) * 3.18 * (1-0.4)

=7.085%

After changes in the new values, the WACC rate is 7.085%, which is much higher than the previous rate of WACC that is 5.993 %. This change demonstrates that a higher value of cost of financing has led to new improvements and development in the operations. It lowers down the debt financing and increase the equity financing. 

References

ThoughtCo. 2017. History of Microsoft - Who Founded Microsoft?. [ONLINE] Available at: https://www.thoughtco.com/microsoft-history-of-a-computing-giant-1991140. [Accessed 28 September 2017].

Weighted Average Cost of Capital (WACC) Definition & Example | InvestingAnswers. 2017. Weighted Average Cost of Capital (WACC) Definition & Example | InvestingAnswers. [ONLINE] Available at: https://www.investinganswers.com/financial-dictionary/financial-statement-analysis/weighted-average-cost-capital-wacc-2905. [Accessed 28 September 2017].

Total Equity for Microsoft (MSFT) - Wikinvest. 2017. Total Equity for Microsoft (MSFT) - Wikinvest. [ONLINE] Available at: https://www.wikinvest.com/stock/Microsoft_(MSFT)/Data/Total_Equity. [Accessed 28 September 2017].

Stock Analysis on Net. 2017. Microsoft Corp. (MSFT) | Debt. [ONLINE] Available at: https://www.stock-analysis-on.net/NASDAQ/Company/Microsoft-Corp/Analysis/Debt. [Accessed 28 September 2017].

Investopedia. 2017. Short-Term Debt. [ONLINE] Available at: https://www.investopedia.com/terms/s/shorttermdebt.asp. [Accessed 28 September 2017].

AccountingCoach.com. 2017. What does current portion of long term debt mean? | AccountingCoach. [ONLINE] Available at: https://www.accountingcoach.com/blog/current-portion-of-long-term-debt. [Accessed 28 September 2017].

Investopedia. 2017. Long-Term Debt. [ONLINE] Available at: https://www.investopedia.com/terms/l/longtermdebt.asp. [Accessed 28 September 2017].

Investopedia. 2017. Capital Asset Pricing Model (CAPM). [ONLINE] Available at: https://www.investopedia.com/terms/c/capm.asp. [Accessed 28 September 2017].

Microsoft Corp WACC % (MSFT) . 2017. Microsoft Corp WACC % (MSFT) . [ONLINE] Available at: https://www.gurufocus.com/term/wacc/MSFT/WACC-/Microsoft-Corp. [Accessed 28 September 2017].

KPMG. 2017. Corporate tax rates table | KPMG | GLOBAL. [ONLINE] Available at: https://home.kpmg.com/xx/en/home/services/tax/tax-tools-and-resources/tax-rates-online/corporate-tax-rates-table.html. [Accessed 28 September 2017].