Chartered Financial Analyst Level 2
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49 An analyst researches three comparable companies that are seeking to raise capital. Selected information from the common-sized balance sheets of the companies is shown in the table below:
| Company 1 | Company 2 | Company 3 | |
|---|---|---|---|
| Cash | 10% | 12% | 16% |
| Marketable securities | 20% | 7% | 5% |
| Other current assets | 13% | 20% | 12% |
| Property, plant and equipment (net) | 40% | 40% | 40% |
| Intangible assets and goodwill | 17% | 21% | 27% |
| Total assets | 100% | 100% | 100% |
Based only on this information, which company is most likely to have the lowest cost of capital?
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A
Company 1
B
Company 2
C
Company 3
Explanation:
Explanation
Correct Answer: A (Company 1)
Analysis:
-
Intangible Assets and Goodwill Analysis:
- Company 1: 17%
- Company 2: 21%
- Company 3: 27%
-
Relationship to Cost of Capital:
- Companies with higher proportions of intangible assets and goodwill typically have:
- Higher business risk
- Lower asset tangibility (less collateral value)
- Higher perceived risk by lenders and investors
- Consequently, higher cost of capital
- Companies with higher proportions of intangible assets and goodwill typically have:
-
Liquidity Analysis:
- Company 1 has the highest proportion of marketable securities (20%), which are highly liquid assets
- Higher liquidity generally reduces financial risk and cost of capital
-
Conclusion:
- Company 1 has the lowest proportion of intangible assets (17%) and highest proportion of liquid assets
- This suggests lower business risk and better asset quality
- Therefore, Company 1 is most likely to have the lowest cost of capital
Key Concept: Companies with more tangible assets and higher liquidity typically have lower perceived risk and consequently lower cost of capital.
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