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General Electric (GE) company Essays

General electric (ge) company

A leading company in terms of wealth creation, profitability and soundness of operations, General Electric (GE) has consistently reaped commendable figures in its financial reports through the years and has good reasons for believing that 2008 will turn out to be yet another great year.  In the 2007 GE Annual Report, a statement from the company’s management goes, “In 2008, we should hit all of our financial goals and outperform the S&P 500.  Our revenues should grow by at least 10% to $195 billion, with organic revenue growth by at least 10%.  Our return on average total capital (ROTC) should near our target of 20%.  We expect to return $18 billion to our investors through the dividend and stock buyback.”  (2007 GE Annual Report)

The market capitalization of GE for the years 2007 and 2006 is computed as follows:

Particulars 2007 2006 Year-end Closing Market Prices (in $) 37.07 37.21 End of period common shares outstanding-ave. 10,182,083,000 10,359,320,000 Total market value of common stocks (in $) 377,449,816,810.00 385,470,297,200.00 The year-end closing market prices are taken from the Yahoo! Finance website.

The end of period common shares outstanding figures are taken from the 2007 & 2006 GE Annual Reports

Most firms raise a substantial portion of their capital as long-term debt, and many also use preferred stock.  For these firms, the cost of capital must reflect the average cost of the various sources of long-term funds used, not just the firms’ cost of equity.   Thus, the Weighted Average Cost of Capital or WACC is the weighted average of the component costs of debt, preferred stock, and common equity.  The weights assigned for the debt, preferred shares and common equity are to be based on the proportions targeted by the company for such capital items.  WACC is equal to the weight used for debt multiplied by after-tax cost of debt, plus weight used for preferred shares multiplied by cost of preferred shares, plus weight used for common equity multiplied by cost of retained earnings.  (Eugene Brigham and Joel Houston; 1998, Fundamentals of Financial Management)  Thus, the formula for WACC is as follows:  WACC = wdkd(1-T)  +  wpskps  + wceks.

GE has issued only common shares thus far, so we can do away with the portion of the formula that is pertaining to preferred shares.  The following are balance sheet figures of GE derived from the financial statements for the year ended December 31, 2007, except the Total Market Value of Common Stocks:

Particulars (dollars in millions) 2007 Weights (%) Total Short-Term Liabilities 246,113,000,000.00 Total Long-Term Liabilities 425,661,000,000.00 Total Liabilities/Debt 671,774,000,000.00 58 Total Market Value of Common Stocks 377,449,816,810.00 Retained Earnings 117,362,000,000.00 Total Common Equity 494,811,816,810.00 42 Source:  2007 GE Annual Report

With no preferred shares as of the year-end of 2007, the capital components of GE are just debt and common equity (common stocks plus retained earnings).

Authors Frank Reilly and Keith Brown in their book entitled, “Investment Analysis and Portfolio Management” have defined the Capital Asset Pricing Model or CAPM as a model that indicates what should be the expected or required rates of return on risky assets.  As such, it is a tool for valuing an asset by providing an appropriate discount rate to use in dividend valuation models.  CAPM is also one approach to estimating the cost of retained earnings.  (Eugene Brigham and Joel Houston; 1998, Fundamentals of Financial Management)  To use CAPM to estimate the cost of retained earnings, the following figures must be estimated:

The risk-free rate, kRF, as provided

3.80% The stock’s beta coefficient, bi, to be used as an index of the stock’s risk. (source:  Yahoo!Finance)

0.44 The market risk premium, RPM, as provided


Using the preceding values, we then come up with the CAPM equation:

ks = kRF          + (RPM) (bi)

    = 3.80%  + (5.10%)  (0.44)

    = 3.80% + 2.24%

    = 6.04%

To estimate GE’s cost of debt, its bond rating is needed.  Moody’s Investors Service has rated the GE bonds “AAA”.  In the light of its rating, the basis points that apply to GE are as follows:

Terms Reuters Corporate Spreads for Industrials Estimated Cost of

Debt One (1) year or Short-Term

15 or 0.15%

2.31% Ten (10) years or Long-Term, kd 55 or 0.55% 4.56% Source:  Bondsonline Website

The cost of short-term debt is the sum of the shortest spread (0.15%) and the one-year yield on the Treasury Bond (2.16%). (Bankrate Website)  Then, the estimated cost of long-term debt is the sum of the 10-year spread (0.55%) and the 10-year yield on the Treasury Bond (4.01%).  (Bondsonline Website)

In the computation of the WACC, the estimated cost of the long-term debts will be used as the general cost of debt.  To compute the WACC using the CAPM, we come up with the following equations:

                                          WACC =         wdkd(1-T)         +  wpskps  +  wceks

                                                       = 0.58 (4.56%) (1-0.35)  +      0      + 0.42 (6.04%)

                                                     = 0.58 (4.56%) (0.65) + 2.54%

                                                     = 0.58 (2.96%) + 2.54%

                                                     = 1.72% + 2.54%

                                                      = 4.26%


         wd  and wce are the weights used for debt and common equity respectively.

         ks represents the cost of common equity from retained earnings, as computed above.

         kd represents the cost of long-term debt, as shown above

        The foregoing computation uses 35% as the effective tax rate, as provided in the    assumptions.

General Electric Computations Dec. 31, 2007 (in US$) EBIT (Source:  Yahoo! Finance) $50,385,000,000 Tax Rate 35.00% (1-T) 65.00% NOPAT = EBIT * (1-T) $50,385,000,000 X 65% $32,750,250,000 Capital (NWOC) $115,559,000,000 EROIC (NOPAT/CAPITAL) $32,750,250,000/$115,559,000,000 28.34% WACC 4.26% EROIC – WACC (positive) 24.08% Market Value Added 377,449,816,810 – 699,000,000 376,750,816,810

2007 2006 2005 2004 2003 Sales (in millions) 172,738 151,843 136,580 124,176 104,624 Net Profit (in millions) 22,208 20,742 16,720 17,222 15,518 Total Equity (in millions) 115,559 111,509 108,633 110,181 78,873 Growth Rates (g) 13.8% 11.2% 10.0% 18.7% Operating Profitability (OP) 12.9% 13.7% 12.2% 13.9% 14.8% Capital Requirement (CR) 1.5% 1.4% 1.3% 1.1% 1.3% Note:  All FS figures were taken from the 2007 GE Annual Report

Thus, GE’s cost of capital is generally way below its promised return on capital which is pegged at 20% in the near future.   GE has hitherto been a strong and financially sound giant, but investors and other stakeholders are yet to see the impact of the credit crisis on the company’s operations once the financial statements of the first half of 2008 are submitted and published by the GE management.


2007 GE Annual Report.  GE website. (http://www.ge.com/ar2007/index.jsp)

Brigham, E. and J. Houston.  Fundamentals of Financial Management. Orlando, Florida. The Dryden Press, 1998.

Reilly, F. and K. Brown. Investment Analysis and Portfolio Management. Orlando, Florida:  The Dryden Press, 1997.

Yahoo! Finance Website (http://finance.yahoo.com)

Moody’s Investors Service Website (http://www.moodys.com)

Bondsonline Group, Inc. (http://www.bondsonline.com); (http://classes.bus.oregonstate.edu/spring-07/ba440/Other%207%20handout%203.doc)

Bankrate Website (http://www.bankrate.com/brm/ratewatch/treasury.asp)


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