(Asmainfo) Regression gave these results: Intercept Slope(Beta) R Square -.0007 .152 .013 The intercept (alpha) represents the return in excess of the risk borne by investors if its value is positive and if its value is negative it represents the lesser returns for the risk borne. Intercept of ADIB is quite low here so it doesn’t affect the returns too much. The slope is the beta of ADIB stocks which is .152. Beta can be interpreted as the change in return of ADIB stocks due to change in Index return. The value of beta is quite low for ADIB thus ADIB stock return is not very much dependent upon market returns. R Square is the coefficient of determination. It tells us the level of stock return dependency on the market return. In other words it measures the level of systematic risk. The systematic risk is quite lower for the ADIB stocks due to lower R Square value. Company specific risk or non systematic risk can be found by 1-r square, which is .987 or 98.7%. This means that most of the beta risk is defined by business and financial factors of the business not the market. The beta is actually levered beta which means it has two components in it; one is the risk due to financial leverage and second is the risk due to business factors. Beta asset (unlevered beta) can be calculated as follows:
E=31400m AED D=22516m AED In order to calculate the cost of capital of NBAD we must first calculate the cost of equity. Cost of equity can be calculated using capital asset pricing model (CAPM). The formula of return on equity according to CAPM is: Where Rf is risk free rate of return, Rm is market return and is beta equity (levered beta) of firm. Rm-Rf is called risk premium. Risk free rate is 2% in UAE and risk premium is 6.75%.Using these rates and levered beta (.510) we calculated the return on equity 5.44%. (Newyork University,n.d;UAE Deposits,n.d) Now using all the required data we have calculated WACC 4.97%.
Retention of profits to finance future projects, giving higher level of dividends and timely information in the form of investors’ presentation on website mean the managers of NBAD are actually in line and performing in the interest of shareholders. NBAD board of directors also has a number of independent and non executive directors who scrutinize the bank’s performance in the best interest of shareholders. Debt holders can find relevant information regarding shareholders on NBAD’s website, through analyst’s covering the bank and recent developments. The bond rating of NBAD is very high and they have lowest credit risk so is very less risk involved for debt holders. We can further look to the level of cash balances maintained in previous years. The high level of cash balances is a good sign from debt holders’ perspective and it may also means that a firm is not using all resources on risky and bad projects. The of cash maintained in previous years was higher as compared to a significant decrease in 2011. The decreased level of cash may put doubts on the credit risk of the bank in future and thus the ratings however as long as the bank is using these resources in profitable opportunities they will earn better returns. The bank has set a number of targets for the future includes entering into new markets such as India, Iraq and Brazil to increase the geographical diversification, investing in SME segments and achieving 16bn Net Profit in 10 years time at the growth rate of 16%. The targets are
close to the cost of debt and if we incorporate more debt it will rise. Cost of debt also rises as gearing level increases; this is because of increased credit risk and firm’s ability to pay interest on time. Current cost of capital of the bank is 3.02% and it will increase if more debt is introduced. The WACC will be lower at lowest possible gearing level however since it’s a financial entity(bank) we can’t eliminate long-term debt altogether but can conclude that it should keep the gearing level as low as possible. If we incorporate more debt at this point in this company ideally the share price will fall as the company becomes more risky to risk-averse investors however some investors believe that incorporation of debt in capital structure is a cheaper source of finance which can earn better return at lower cost so they might invest more money. Abu Dhabi Stock Exchange is not a very efficient market so we can expect that share price will not show significant change in short term if the incorporates more debt. ADIB’s current rating according to moody’s is A2 and A+ according to fitch’s. For under leveraged firms the ratings go downside pattern if optimal capital structure is reached through more debt incorporation however ADIB’s position is in contrast with that since it’s over leveraged if we reach the lowest gearing levels it would reach better rating. Ratings are also dependent upon the volatility of operating income. The operating income of ADIB shows a positive trend as it’s a growing bank. The relative analysis can be made with banks operating in the same jurisdiction and listed in Abu Dhabi Stock Exchange.
ADIB’s gearing ratio is lower relative to these banks except for Sharjah Islamic Bank. The high gearing ratio is not profitable for these banks because of the no tax advantage as we mentioned previously. National Bank of Abu Dhabi The optimal structure is ideally the structure where firm’s value is highest. As we know that market value of a firm is the present value of its future cash flows, discounted using WACC. Mathematically the value of a firm will be highest once we find the lowest WACC. The level of capital structure where WACC is lowest can be effectively called the optimal capital structure of a firm. Debt is regarded as a cheaper source of finance than equity due to two reasons; one is tax advantage of debt and second is the lower cost due to low risk. If we introduce more debt into a capital structure it will reduce the WACC as equity holders always require more returns than debt holders. By this introduction of debt, the WACC will fall but WACC is actually the weighted average of cost of debt and cost of equity so when we introduce more debt it will increase the gearing levels and thus the risk for shareholders. Shareholders will require more returns consequently and at very high levels of gearing risk for debt holders will also increase and they also will also require high returns. Lowest WACC can be achieved somewhere between the highest and lowest levels of gearing. In our case the bank is based in no tax world so no advantage can be made of debt. The beta of company is also lower than the market which resulted in lower cost of equity; in fact cost of equity is still very close to the cost of debt and if we incorporate more debt it will rise. Cost of debt also rises as gearing level increases; this is because of increased credit risk and firm’s ability to pay interest on time. Current cost of capital of the bank is 4.97% and it will increase if more