Aveneu Park, Starling, Australia

The observing their common shares. Reviewing Exhibit

The Encana case Study is primarily focused on calculating
the cost of capital for the firm. It begins with two managers at a weeklong
executive educational business course discussing the cost of capital. Both seem
to have their different approaches when calculating Encana’s Cost of capital.
Encana is a large oil and gas producer containing three quarters of natural
gas’s, thus leading as the largest producer in North America. The objective for
the two mangers were to figure out the cost of capital and the rate of return
which is  the minimum rate a company can
earn when investing into a project.
I will be looking at analyzing Encana’s Cost of capital to help the mangers
with their final decisions on this case. In order for us to ensure we make the
appropriate decision we will need to calculate Encana’s weighted average cost
of capital. To do so, we will need to figure out the companies, Cost of Equity,
Cost of debt, and its Capital Structure. These are crucial components to help
measure the company’s stance financially. The Cost of Debt is used to help
determine the interest the company uses to pay on its borrowing. We can view
their Short term debts and Long term Debts in combination to confirm how
efficiently the company is operating when it comes to paying back its
debts.  The Cost of Equity is used to
determine how proficient we are in the market and in our market returns. It
will give us an idea of how much equity our shareholders make back. Lastly we
will focus on the Capital structure on how Encana is overall operating and
growing by computing its market debts such as their bonds etc. and market
equity by observing their common shares.

Reviewing Exhibit 3, Encana’s schedule of debt, we can establish their Long-term debt totals of $6,629. There short
term debt was $1,425, giving us an overall total debt of $8,504. Given their
total debt we can compute Encana’s Capital structures of debt and the equity of
the firm. We were given that Encana had 854.9 outstanding shares, and were
advised by one of the mangers the shares were going for $56.75. Knowing this
information we can conclude that our total capital is $56596.58 Million
calculated by adding our equity and debts together. To finalise our capital
structure, if we divide our debt and equity by the total capital we will view
that Encana is made up of 14.23% Debt and 85.77% Equity. This tells us that
Encana is financially stable ensuring that they have a ton of room for more
Now in order to calculate the entire firm’s weighted average, we will need to
figure out the cost of Debt after taxes. Referring back to Encana’s balance
sheet shown on exhibit 1, I had calculated Encana’s short term and long term
debts by using the debts accounted from other investors such as publicity
traded bonds, short term obligations etc. In the case it also states that our
short-term debt, the average interest rate was %3.52. For the long-term debt,
if we relate back to the managers conversation they had indicated that the
prime rate was at %5.25 which we can use to calculate long-term debt.  After computing our debts we concluded we had
$50.16 mil in short term interest and 406.75 mil in long term. These values
were needed to calculate our after tax cost of debt. By dividing interest
expense over net earnings before tax we obtained our Tax rate of %30.81 leading
us to calculate our final debt after tax at %4.50. Because we are trying to
calculate the capital cost on this case, the tax is not exempt and therefore
would need to be included to ensure we cover all grounds of debts.

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We will now calculate Encana’s Cost of Equity
to ensure we have a constant return on our investments. This will give us an
idea of how the company is operating in the market, and weather we are
investing appropriately when by looking at their returns. We focused on using
the CAPM (capital asset pricing model) to help measure the variance level in
the market on the risks we are taking, whether they are good or bad decisions.
This model uses historical performance to help predict the future output results
of our investments. We have also used the dividend growth model as an
alternative method for calculating the cost of equity to show these results
through dividends paid.  To figure out
CAPM, we had to analyze the expected market return and the risk free rate. We
obtained these from the arithmetic average for the markets expected rate of
returns, and the rate of return on their risk free securities such as long
–term treasury bills etc. We also required using beta level that one of the
managers found at 1.27, which was based on historical returns, measuring the
stocks volatility in relation to the index market. We concluded our analysis
and computed CAPM for Encana to have a 16.52 % growth rate on their cost of
equity. We also compared that number to the dividend growth model and found it
is relatively similar at 16.71%. This was done by viewing Encana’s Next year
dividend and dividing that by the current price less the floatation cost
(underwriting fee’s etc) take that and add the growth percentage, which provided
us with our result. This tells us that Encana is operating efficiently and
providing a constant return to our investors who continue to take risks in
investing into the company. Our shareholders will continue to take risks which
will generate us more equity and allow the company to take on more projects and
The managers were trying to figure out Encana’s Cost of capital and had many
ideas on how to calculate it, weather it was to issue debt to fund new projects
, or if they should just use the hurdle rate’s interest when funding’s those
projects. This leads us to our final question on what is Encana’s weighted
average cost of capital?   With the WACC
, we will be able to evaluate the value of Encana and its financial operation
using its debts, equity, stocks etc.  So
far we have calculated the firms Cost of equity at an average between the two
methods (CAPM, Dividend growth model) at 16.62%. We also figured out the cost
of debt (short term and long term debts) and concluded that after tax cost of
debt to be 4.50 %.  By having all our
total equity and total capital computed as well, we can now compute the
weighted average at 14.88%. This implies that Encana’s cost of capital is
operating efficiently. Overall their financial stance is estimated at a good
range, where it is not considered too high of a risk to invest in, as they are
averaged and preforming great. They have a lot of room for future investments
as they have more equity then debt, and are in a favorable financial position
to do so. For future projects, we can measure the opportunity cost on whether
we should take it on by comparing the net present value to our WACC. This will
assist the managers to come to an agreement when deciding to fund a new project.


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