Financial assesment - Aviva PLC Research Paper Example | Topics and Well Written Essays - 4000 words

Financial assesment - Aviva PLC - Research Paper Example Firms calculate their cost of equity using several methods, the most popular method being Capital Asset Pricing Model (CAPM). This method assumes that shareholders expect a rate of return equivalent to the risk free rate plus a risk premium, and is expressed as - The current UK T-bill average yield was taken as the risk free rate. The recent T-bill average yield varied from 0.6725% (on Apr 3) to 0.6220% (on Mar 27) as per Financial Times (2009). The extract of the data is given in the Appendix as Exhibit 6-3. The average of these two figures (0.65%) was considered as the risk free rate. FTSE-100 was considered as the indicator of market return. The data range considered was between Jan 1, 2003 to Jan 1, 2009. The compounded annual growth rate (CAGR) of FTSE-100 during this period was 2.55%. The relevant FTSE-100 data during this period is given in Table 6-1 of Appendix (Yahoo Finance 2, 2009). It is assumed that this is the rate of return that the market will expect in future. The historical dividend growth rate of Aviva works out to 6.20%. The divided payout details are given in Table 6-2 of Appendix (Aviva, 2009). It is expected that this growth rate will continue in future. A total dividend of 33 pence per share was paid for the year 2008. This amount is expected to be 35.05 pence per share during the year of 2009 using the current dividend growth rate. The share price of Aviva as on January 1, 2009 was 361.84 pence. There is subsThe cost of equity as per this method works out to (0.33 x 1.0620/ 361.84) + 6.20%, i.e., 15.89%. There is substantial difference between the cost of equity calculated using the two methods. Both methods use several assumptions and approximations. Therefore, it was decided to take the arithmetic mean of both these figures for the purpose of calculating the WACC. The arithmetic mean works out to 10.42%. Preference Shares/ Direct Capital Instrument: The Aviva has issued several types of hybrid instruments at different rates of