Cost of Capital of Dublin Airport Authority

Rimee Raghuwanshi
Abhishek Meel

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Introduction

The aim of this report is to calculate Cost of Capital for Dublin Airport Authority. Data has been collected from the DAA annual report 2017 and external sources with a hope to achieve a realistic estimate.

The report consists of:-
The estimated value of the cost of equity is calculated using the Capital Asset Pricing Model (CAPM). This model is mostly used for finance and pricing of risky securities. The CAPM is a model which explains the relationship between systematic risk and expected return of an asset.
Through the corporate borrowing rate, the cost of debt is estimated. Lastly with the help of weighted average, the Cost of Capital is calculated.

1. Cost of Capital
The cost of equity is calculated through the CAPM method.

D = total debt of DAA
E = total equity of DAA
rf = risk free rate of market
? = beta coefficient

Cost of equity is the rate of return that equity shareholder gets on their investments. As DAA is a private listed company, therefore we have used CAPM to calculate cost of equity.

Ke = Rf + ?lev x (ERP – Rf)

For calculating the risk free rate , we have considered the German Government bonds (section 1.1). Furthermore , Beta shown above measures the non-diversifiable risk. However due to the nature of the DAA Beta in this form is not adequate. Hence two Betas are required to give the whole scenario,

To get the equity beta, the asset beta for the industry is used as whole (section 1.1)
?unlevered = ?levered / 1 + (1 – t) x (Debt/Equity)

This figure represents the equity beta for DAA that has been adjusted for gearing, now using this value for the cost of equity for DAA can be found.

Ke = Rf + ? x (Rm – Rf)

Section 1.1 – German Government Bonds
We have used German Government 10-year bond yield as the risk free rate because of its risk-free nature. This is wildly used practice in the Airport industry, mostly in Europe. Another reason to choose German bonds is that they have low interest rate and relatively stable economy so the German bond is used for calculation.
German Government 10-year bond yield = 0.531% (percentage as of 5.10.2018)
Irish Government 10-year bond yield = 1.052% (percentage as of 5.10.2018)

Section 1.2 – Asset Beta
As indicated above, the asset Beta is the unlevered beta. Assets Beta’s Formula excludes company’s borrowings for computation of the Equity only.
To get a reliable representation, three Betas were obtained and averaged. Initially, we have used a general Asset Beta for the airline industry was sourced, at 0.55, Asset Beta 2013 for airport section 0.55 (www.iata.org, 2013).
Next, an equivalent, airport authority, Airports of Thailand PCL (AOT) was compared. The Asset Beta in 2017 of AOT is calculated from its equity beta. The formula is
?Asset =?Equity/1+(1-Tc)*D/E,

where D and E indicate the company’s total Debt and Equity respectively, and Tc from is the corporate tax rate. In 2017 the corporate tax rate was 20%, and the total debt to total equity ratio of Airports of Thailand PCL in 2017 was 16.19 (https://quotes.wsj.com, 2017)

And thus the Asset Beta of Airports of Thailand PCL in 2017 is 0.759
Finally, Airports of Thailand PCL beta was found.
Airports of Thailand PCL are liable to be subject to the same degree of systematic risk that consist of inflation, GDP, tax law, interest rates, product price and exchange rate. Further the current soars up in airport asset betas is typically of their future performance. It is vital that the commission explains why there has been a significant escalate in the systematic risk faced by Airports of Thailand.

Section 1.3 – Equity Risk Premium

The equity risk premium, refers to the surplus return that infusing in the share market supply over a risk free rate.
The Total Equity Risk Premium for Ireland is 7.04%

2. Cost of Debt
Since the airport industry nature is low risk, the book value of DAA debt we used is equal to the book value of the industry as whole.
To calculate the cost of debt, we need the values of total interest payable and total debt figures from the DAA annual report. Comparison of two years was adequate, as the quantities did not change materially.

Function Name Data (€) Explanation/ Equation
Total Interest Payable 2017 41594 M From the DAA Annual Final Report 2017

Average Debt 2016 572 M Therefore, Average Debt is 556.5

2017 541 M

Interest (I) 7.47% Annual Interest Payable / Average Debt

Tax Rate 12.50% Average tax rate paid in Ireland

The Net debt figure equals €541 million
Cost of Debt = Interest rates paid x (1-Tax Rate), the Corporate Tax rate is 12.5%, and the Interest rate paid = Total Interest payable/Average Debt of 2016 and 2017, which is 7.47%.
Using the above formula, the interest rate paid was 7.47% and the tax rate being 12.5% the Cost of Debt turned out to be 6.53%.

3. Weighted Average Cost of Capital
Weighted average cost of capital is the discount rate used in the calculation of net present value (NPV) and other valuation models such as free cash flow valuation model. It is the hurdle rate in the capital budgeting decisions.
Below are the values used for calculating the Cost of Capital by first deriving the values of Cost of Debt and Cost of Equity using the following values:

Airports of Thailand PCL
# Function Name Data Description
1 EBITDA 31,430.0 From AOT Annual report 2017;
(Cash value is in million euro)
2 Cash or Cash equivalent 9,317.7
3 Share Value 64.0 From www.bloomberg.com
4 Total shares 14,290.0
5 Equity Value 914,560.0
6 Net Debt 23,890.0 From AOT Annual report 2017;
(Value is in million euro)
7 Gross Debt 33,207.7 Addition of cash and net debt
8 Enterprise Value 947,767.7 Addition of gross debt and equity value
9 Enterprise multiple 30.2 Derived by dividing enterprise value by EBITDA

Dublin Airport Authority
# Function Name Data Description
1 EBITDA 271.00 From DAA Annual report 2017
2 Enterprise multiple 30.15 From AOT PLC above
3 Enterprise value 8170.65 Addition of gross debt and equity value
4 Net Debt 541.00 From DAA Annual report 2017;
(Cash value is in million euro)
5 Cash or Cash equivalent 595.00
6 Gross Debt 1136.00 Addition of cash and net debt
7 Equity value 7034.65

To derive the Asset Beta for DAA PLC, we need the levered beta of DAA and industry-wide betas. We take their average and calculate the asset beta for DAA.

Function Name Value Description
IATA Report 0.55 Industry-wide
New Zealand study, Airport Beta estimated 0.53
DAA levered beta 1.197 DAA PLC
Average 0.759

Weight of Debt: w(D)
It is calculated by dividing the market value of the company’s debt by the sum of the market values of equity and debt.
w(D) = 10% (Market value of company^’ s debt (€447 M))/(Sum of market values of equity and debt (€4444.4 M))
w(E) = 90% (Market value of company^’ s equity (€3997.4 M))/(Sum of market values of equity and debt (€4444.4 M))

Ke (Cost of Equity) = 6.17% (Calculated above)
Kd (Cost of Debt) = 6.53% (Calculated above)

WACC = (0.1 x 6.53) + (0.9 x 6.17)
= 6.20%

Conclusion
Drawing on market values, figures of the competitor (AOT PCL) and DAA’s financial statements, a clear systematic approach for calculating the WACC was approached, reaching the figure of 6.20% Weighted Average Cost of Capital for Dublin Airport Authority for 2017.
WACC shows how much of an average risk an organization may face. It would require an upward adjustment if it must be used to calculate NPV of projects which are riskier than the company’s average projects and a downward adjustment in case of less risky projects. Further, WACC is after all an estimation. Different models for calculation of cost of equity may yield different values.
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