Telus: The Cost of Capital
Business 3019

Synopsis
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Two managers attending an executive education course attempt to develop a cost of capital estimate for a leading telecommunications company, Telus The two managers are somewhat confused about the costs of various sources of capital, the calculation of the overall cost of capital and the appropriate use of the hurdle rate

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What Does Cost of Capital Mean?
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Cost of capital is what it will cost the firm, on the margin, today, to secure its financial resources for further growth.
• Cost of capital must reflect current capital market conditions (current required returns) • Cost of capital must also reflect the optimal relative proportions of debt and equity the firm will …show more content…

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The footnote in the case indicates that underwriting costs are approximately 0.50% of the total cost of long-term debt financing (9.31% 8.81%). When the underwriting costs are unknown for long-term debt, 0.50% is often used as a generally acceptable amount. While this analysis incorporates underwriting costs, often, in practice, underwriting costs are ignored or overlooked.

How Should the Short-term Notes be Treated?
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If short-term notes are considered to be a permanent source of short-term debt, then the cost of short-term debt may be included with long-term debt when calculating the cost of debt. In other words, even though the short-term notes all expire within one year, the company will continuously issue new ones. We assume here that this is the situation, and therefore, we include short-term notes in the cost of debt that is incorporated in the cost of capital.

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How Should the Short-term Notes be Treated?
Type of Projects

Typical projects are long term.  Therefore, the cost of debt should match the typical length of the projects (maturity matching principle)
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How Should the Short-term Notes be Treated?
Yield Curve Issues

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If one is prepared to accept the ‘ unbiased expectations’ hypothesis, then even though current short-term rates are lower than long-term rates, one would expect future short-term rates to be higher, and on average, equal to the long-term rates. Such an argument provides