FedEx Corporation offers worldwide delivery services in the overnight and ground businesses, along with other related logistics services. The company operates around the world, utilizing either wholly-owned subsidiaries or service partners to gain market entry. If the company is considering making an investment in a foreign country, it can start by determining the cost of capital. Most of the company’s business is in the U.S., so the domestic cost of capital is applicable. There are different methods of financing that could be used to fund the expansion, debt or equity. Debt financing has the benefit of a lower cost but it also increases the risk that the company faces. Equity financing has a higher cost but carries with it less risk, since less of the company’s cash flows are going towards debt service. Moreover, if the company wants to match the term of the financing with the term of the project, a new market entry for FedEx is of infinite time frame and will therefore match better with equity financing.
In considering where to expand, FedEx needs to look at a number of market factors. The first is that the company needs to examine what the potential demand is. Macroeconomic variables like GDP or GDP per capita are good indicators of suitable markets for the company, since countries that are too poor will have little market for FedEx’s premium shipping services. In some poor countries, there are cities that have enough wealth to sustain the company, so it maintains a limited presence in some markets, servicing only the areas with good earning potential. The company might also wish to consider the costs of entering a market, which would naturally be weighed against the benefits. There are a couple of major cost factors for FedEx. The first is the salaries and wages of the workers, which are high in developed countries but somewhat lower in many of the markets that remain untapped for FedEx. The company’s other major expense comes from its fleet — aircraft, vehicles and fuel. These are more constant around the world, though in some countries there are differentials in fuel price. The revenue will be affected by the local market conditions, especially competitive benchmarking.
The weighted average cost of capital is calculated by looking at the cost of debt and the cost of equity. The capital structure of FedEx is 47.7% debt and 52.3% equity as of Q2 FY 2014 (MSN Moneycentral, 2014). FedEx has just completed a bond issue with a yield of 4% on the 10-years (Robinson, 2014). The cost of equity is calculated using the capital asset pricing model. The risk free rate is 0.117% on 1-year Treasury, according to Yahoo Finance. The market risk premium is assumed to be 7%. The beta for FedEx is 1.50. Thus, using CAPM, the cost of equity is as follows:
0.117 + (1.5)(7) = 10.62%
The weighted average cost of capital tells us what the cost of capital for FedEx is, given the firm’s capital structure, its cost of debt and its cost of equity.
(.477)(4) + (.523*10.62) = 1.908 + 5.554 = 7.46%
This cost of capital is likely going to decline in the future, as FedEx is embarking in an aggressive share buyback program. This is because the company can borrow at very low rates. The company’s stock has increased significantly in the past year, and may well be overvalued at this point, but the buybacks help to prop up the value of the stock to the benefit of the shareholders.
MSN Moneycentral. (2014). FedEx Corporation. Retrieved January 23, 2014 from http://investing.money.msn.com/investments/stock-balance-sheet/?stmtView=Qtr&symbol=FDX
Robinson, M. (2014). FedEx sells billion of debt in three parts, credit swaps hold. Bloomberg. Retrieved January 23, 2014 from http://www.bloomberg.com/news/2014-01-06/FedEx-said-to-plan-2-billion-bond-offering-credit-swaps-hold.html