Pan Canadian Energy Corporation and Alberta Energy Company

“EnCana”

UTSABALLERS

Bradley Griggs

Bryan Arias

Karan Patel

Fin 4893-002

2:30-3:45

2/14/2019

EnCana

Background

In 2002, through the merger of Pan Canadian Energy Corporation and Alberta Energy Company, EnCana was created. The main focus and vision of the company was on the development of oil and gas fields and on selling the company’s production of natural gas, crude oil and natural gas liquids. At the headquarters located in Calgary, they are the largest natural gas producers in North America with over 80% of operating cash flow solely being natural gas. For the year 2005, EnCana had net earnings of upward of $3 billion and shares outstanding of 854.9 million. The overall return on the stock for the years 2002-2005 was 28.32%. The company’s profile has one of the highest growths in North America with almost 500 MBD (millions of barrels per day) oil sands bitumen expected by 2015.

Issue

For this issue we must look at the information presented in year 2005 of EnCana’s income statement and balance sheet. (Exhibits 1,2) The issue and objective are to find the weighted average cost of capital of EnCana and what recommendations are best for using this cost of capital because most business decisions require capital to use. In order to find the WACC of this firm we must compute some basic components of the WACC formula. The components are common stock and debt, along with their weights.

Analysis

Cost of Debt

When calculating the WACC, the first step is to find the cost of the debt and to determine how much investors are requiring for a return. EnCana uses 30-year bonds to raise long-term debt in order to finance its capital projects. The yield to maturity is the rate of return that debtholders expect to make, and it is a great estimate for “Rd.” The current required rate of return for EnCana debt holders is 5.81%. The after-tax cost of debt (Rd*(1-t) is used to calculate the WACC. From the information given in the 2005 income statement we can calculate the tax rate. So, if we take the income tax and divide it by net earnings as shown in the excel sheet, the calculated tax rate would be 30.81%. From this point, we can use the numbers calculated above to determine the after-tax cost of debt to be 4.02%.

Cost of Equity

The next part to calculate would be the cost of equity. However, there are two ways in which this can be done. The first, which will be explained below, uses CAPM to find the cost of equity of the firm. To estimate the cost of common stock, we start with estimating the risk-free rate. We did not need to actually perform any calculations, instead we just used the T-bond rate of 4.2%. The market risk premium, MRP, which is expected market return less risk-free rate will be used from the arithmetic average return seen on Exhibit 5. The return is 7.4%. As we know the beta of 1.27 is already given as well in the information so we now have all of the information needed to calculate CAPM. Using the formula for minimum return, we can see that the number calculated is 13.60%. This would be your cost of equity if we used the CAPM approach.