In our fifth week of understanding the practices of Corporate Finance, we reviewed the Cost of Capital video. This video provided information on Pfizer, a researched based pharmaceutical company that makes products to help face health care challenges. Our goal is to highlight the cost of capital as described by Amit Singh regarding Pfizer’s funds in terms of debt and equity along with using the Capital Asset Pricing Model (CAPM). The Weight Average Cost of Capital (WACC) and how Pfizer uses this method will be reviewed. Additionally, each phase of developing and creating new value added drugs role financially will be addressed.
According to Parrino, Kidwell and Bates (2012), the capital asset pricing model describes the relationship between an associated risk and the expected return on an asset. Pfizer uses the CAPM to determine its cost of capital or the weighted average of the costs of debt and equity held in a company’s capital base. Singh states “standard models for a company’s capital structure focus mainly on tax benefits related to leverage and distress costs” (Treasury & Risk, 2011). So when seeking the optimal capital structure for its company, Pfizer mainly focuses on the equity side, which observes the risk-free rate on its treasury bonds, beta calculations based on the historical performance of its stock, and the market risk premium which is not defined figuratively. Debt versus Equity
Debt is the amount of money that they firm has borrowed from others who are loaning money in return for a promised interest. On the other hand, equity is what the investors in the stock have invested in the company, and there is no expectation of routine interest to be paid back for that slice of the capital that the company has borrowed. Pzier looks at the amount of debt that goes into the weighted average cost of capital formula and they focus on the net debt. Net debt is the amount of debt that any company holds in excess of cash. According to Singh, today, with over 42 billion in debt and over 33 billion in cash, they would consider 7 or 8 million dollars of net debt in their capital structure, which means that capital structure is primarily equity (Parrino, Kidwell and Bates, 2012).
Parrino, R., Kidwell, D. S, & Bates, T. W. (2012). Fundamentals of corporate finance (2nd ed). Hoboken, NJ: Wiley Seeking the Optimal Capital Structure: Pfizer. (2011). Treasury & Risk. Nov2011, Vol. 21 Issue 10, p31-31. Retreived from ttp://web.b.ebscohost.com.contentproxy.phoenix.edu/ehost/pdfviewer/pdfviewer?vid=1&sid=d63ff10d-69a5-4438-bb66-1766854b1617%40sessionmgr113&hid=110