FNCE 317: Introduction

to Corporate Finance
Spring 2021 - Assignment 2

JUNE 19, 2021

Proposed to: Thomas Holloway

Proposed by: Ivy Lee, Akansha Malik, Madison Michiels,
William Roy-Cote, Phuong Trinh

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Part 1: Risk, Return, and CAPM
Introduction
To summarize our report, we chose the securities Granite Real Estate Investment Trust (GRT-UN),
Rogers Communications Inc. (RCI-B.TO), Dollarama (DOL.TO), and BMO S&P 500 Index ETF (ZSP.TO)
for our portfolio. Analyzing the initial three years of returns, we optimized this portfolio to determine
the weights that maximize the Sharpe ratio by assuming the risk-free rate is constant at 1%. We had a
Sharpe ratio of 1.83. This max Sharpe ratio is an indicator that the portfolio consists of the least risk
with the most return. Using the optimal blend weights, we determined the tangent portfolio and
used the weights to predict returns for the next two years.

Risk Vs. Return

To begin, this scatterplot displays the risk versus return for each of the four securities we have
chosen. This graph also illustrates the 26 different portfolio blends labelled in grey and the tangent
portfolio (TP) labelled brown. The TP has a return of 16.4% and a risk of 8.6%, which is optimal since
the portfolios that contain 100% of an individual security have a greater risk.

Additionally, a noteworthy component of this graph is that blend 11 has a return of 16.4% and a risk
of 8.5% and blend 21 has a return of 16.6% and a risk of 8.9%. As such, they are plotted very close to
the TP and the Capital Market Line. Upon initial observation, these two blends have quite similar risks
and returns as the TP. However, they retain more risk than the TP, justifying that the TP is an ideal
trade-off between risks and returns.

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Tangent Portfolio Weight
The Excel Solver add-in optimized the TP to consist of 5% DOL, 20% RCI-B, 56% GRT-UN, and 19% ZSP.
The optimal TP blend gives us a Sharpe ratio of 1.83, which is the highest possible ratio for this
portfolio. An interesting feature of this TP is that it contains more than half of GRT-UN. However, it is
mathematically reasonable as GRT-UN has the highest average annual returns of 19.9%.

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Individual Security Betas
We computed beta for each security with respect to the TP by using two methods. First, as the slope
of the regression between the individual security returns and the TP returns. Next, we confirmed this
by manually calculating beta with the covariance-based formula. As such, the betas did in fact match.
Furthermore, each scatterplot has the TP on the x-axis and the individual security on the y-axis.

The slope of trendline (or beta) for each chart represents the changes in security with respect to the
TP. The betas calculated for DOL, RCI-B, GRT-UN, and ZSP are 1.0427, 0.5658, 1.2252, 0.7865
respectively.

As beta measures the sensitivity of a security to systematic risks, GRT-UN has 1.2252 times higher
systematic risk than the market portfolio. Thus, stakeholders can invest $1.2252 in GRT-UN but still
are exposed to the same systematic risk level as the investment of $1. Contrarily, the beta for Rogers
only stands at 0.5658. Stakeholders are recommended to invest only 0.5658 the amount of funds into
the TP as the risk level is the same for Rogers alone.

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Beta Vs. Return
The chart illustrates how CAPM formula is used for betas and returns of the securities comparison.
We used the betas calculated previously, risk-free interest rate of 1%, and the return of the tangent
portfolio of 16.4% to compute the return for each security. All data points form a straight line, which
is the Security Market Line. This means that the CAPM formula holds total foresight of risks and
returns.

The returns for DOL, RCI-B, GRT-UN, and ZSP are 17.1%, 9.7%, 19.9%, and 13.1% respectively. As the
beta is used as a variable in return calculation in CAPM formula, GRT-UN has the largest beta,
resulting in its largest return. The same pattern also applies to the other securities.

Additionally, we initially had a different security than GRT-UN. We started with Canadian Natural
Resources Limited (CNQ), but this security had negative returns and a negative beta. This security also
had a negative weight when we optimized the portfolio. Since this made sense mathematically but
was difficult to make sense of intuitively, we decided to choose the GRT-UN asset as a replacement.
This security proved to be a better fit due to its positive returns. Furthermore, it added diversity to
our portfolio by incorporating a security that has a high beta or that is sensitive to systematic
changes.

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Beta Vs. CAPM Vs. Actual Return
This scatterplot illustrates Beta versus CAPM and Beta versus the Actual Return for each
corresponding security. The expected returns are labelled by each individual security and their
corresponding colour of red, yellow, green, and blue. Whereas the actual returns are indicated by the
black dots. The vertical difference between the CAPM expected returns and actual returns are the
alpha values. Three of the four securities have a lower actual return in comparison to the expected
return, as labelled by the red arrows. Moreover, RCI-B and GRT-UN both have negative actual returns.
We can also see that the actual return for ZSP is higher in comparison to the expected return, as
labelled by the green arrow.

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Risk Vs. Return
In this scatterplot, we maintain the same betas and TP weights that were calculated using the data
from the first three years. We also use the actual two-year TP returns alongside the CAPM formula to
display the expected return of each security. However, we can observe that the previously calculated
TP weights are no longer optimal for the following two-years of data. This can be seen through the
Capital Market Line, as it does not provide the steepest possible line. Instead, the Capital Market Line
appears inaccurate and almost as a “flat-line”.

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Part 2: Capital Structure
What is the Enterprise Value of both Shaw and TELUS?
Note: All numbers are sourced from Yahoo Finance’s financial statements, specifically the balance sheets for each
company
Shaw Communications Inc. (RCI)
Enterprise Value = Market Value of Equity + Net Debt
Market Value of Equity = Number of Shares Outstanding x Price Per Share
Market Value of Equity = 4,602,000 x $36.24
Market Value of Equity = $166,776,480
Net Debt = Total Debt – Cash and Cash Equivalents
Net Debt = ($201,000 + $4,547,000) – $763,000
Net Debt = $3,985,000
Enterprise Value = $166,776,480 – $3,985,000
Enterprise Value = $162,791,480

TELUS Corporation (TU)

Enterprise Value = Market Value of Equity + Net Debt
Market Value of Equity = Number of Shares Outstanding x Price Per Share
Market Value of Equity = 7,677,000 x $27.49
Market Value of Equity = $210,765,830
Net Debt = Total Debt – Cash and Cash Equivalents
Net Debt = ($1,532,000 + $18,856,000) – $848,000
Net Debt = $19,540,000
Enterprise Value = $210,765,830 – $19,540,000
Enterprise Value = $191,225,830

How do Shaw and TELUS Manage and Measure Capital Structure?

Both Shaw and TELUS are Canadian national telecommunications companies that offer
telecommunication products and services. The key difference between the two telecommunications
companies is the long-term growth stock. Shaw’s stock is a prime option for dividend-growth
investors. While TELUS does not have as much growth potential as Shaw. TELUS makes up for the lack
of growth opportunities for its stability of their business.

TELUS’ capital structure policy is to maintain a flexible capital structure and optimize the cost and
availability of capital under acceptable risks. TELUS incorporates common equity, long-term debt,
cash and temporary investments, and short-term loans from carefully reviewed accounts receivable
into its capital management. To manage the capital structure TELUS makes decisions and adjusts the
number of dividends paid to holders of common shares cancels purchases of common shares in
accordance with the normal course issuer bid programs (if and when implemented), in the first
quarter of 2021 dividends declared per common shares were $0.3112, reflecting an increase of 6.8%
compared to the year prior. In the second quarter of 2021, the dividend increased by $0.02495 per
share. TELUS also focuses on new issues of shares and new debt issues to replace existing debts with
different characteristics, and/or increase or decrease the number of accounts receivable sold to fair
securitization trusts in their capital structure. TELUS’ total debt/equity ratio is 129.4% TELUS’

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accelerated investments in their 5G network increased their capital expenditures by $20 million in the
first quarter.

When it comes to the capital structure of each company, Shaw uses the adjusted EBITDA margin to
measure the analysis related to performance appraisal and to make decisions for the capital structure
of the company. Shaw uses this metric to assess the company's ability to pay off debt and pay
dividends to shareholders. In February 2021, Shaw's net debt leverage ratio was 2.4x, while the total
debt / equity ratio is at 100%. Shaw has an accounts receivable securitization program that allows for
sales of certain trade receivables. Shaw continues to provide services and retains nearly all risks and
returns related to sales of accounts receivable. Therefore, the accounts receivables are still confirmed
in the consolidated statement of financial position of the company and the funds received are
recorded as current liabilities. Based on the aforementioned financing activities, available credit lines,
and anticipated free cash flow, the company expects to have sufficient liquidity to provide financing
requirements for operations, obligations, and working capital, including debt maturing in next fiscal
year.

What Changes have Shaw and TELUS Made and Who is More Leveraged?
Due to the nature of their businesses, both companies have experienced above-average growth due
to the COVID-19 pandemic. When many governments around the world were forced to close all non-
essential businesses, it was companies such as TELUS and Shaw that remained open and saw
additional sales on products, subscriber growth and assets as a result. Both companies emphasized
strong presence in the telecommunications markets during the early phases of the pandemic, with
TELUS securing a strategic alliance with Google, launched their 5G network, made advancements on
Telus PureFibre infrastructures and Shaw introduced Fibre+ Gig 1.5 designed for heavy data users,
launched Shaw Mobile that leverages LTE and Fibre+ network.

TELUS increased by approximately $330 million of operating revenues and income in the first quarter
of 2021 which was partly offset by the impacts of the COVID-19 pandemic. TELUS saw a decrease in
operating income by $12 million in the first quarter of 2021, driven by the lingering impacts of COVID-
19. Costco on the other hand also had very strong performance in Q2 of 2021 with subscribers
increasing the company’s revenue of $1.39 billion increased $24 million or 1.8% from the $1.36
billion from the second quarter of fiscal 2020.

In terms of the leverage each company has acquired, we calculated the total debt/total equity of
each for both 2020 and 2021. Shaw's ratio increased by nearly 9.7% in 2021 to be 100%, while Telus
decreased by nearly 28.3% from 157.7% to 129.4%. As indicated by the ratios it is clear that Telus has
almost 1.3x the amount of equity compared to debt, but Shaw has nearly 1.3x the amount of debt to
equity, despite being in the same industry. Our group attributed this discrepancy largely to the
differences in business model between the two companies. Walmart attributes the majority of its
revenue to service and equipment sales, while Costco's main sources of revenue is its wireless sales.
Despite Telus's total debt/total equity ratio being higher than that of Shaw’s there is little doubt
among creditors and institutions on the ability of Shaw to pay off its debts in the Rogers-Shaw
transaction.

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The Trade-off Model
The Tradeoff Model proposes the idea that a firm should choose its capital structure by weighing the
tradeoff between the tax savings benefit of holding debt (originating from the protection of cash
flows by the Interest Tax Shield) and the drawbacks of the costs of financial distress. Both Shaw and
TELUS pay taxes, with Shaw’s income tax expense for fiscal year end August 31, 2020, at C$179
million and TELUS’ income tax expense for fiscal year end December 31, 2020, at C$451 million. While
it would be possible for both companies to hold more debt and shield a larger amount of their cash
flows from taxes, companies with higher levels of leverage are more vulnerable to default and
therefore at greater risk of bankruptcy and insolvency costs – both of which are additional risks that
many companies are unwilling to bear. However, if Shaw and TELUS wanted to explore the option of
increasing their leverage, they are both part of the utility industry which traditionally have cash flows
with lower levels of volatility. This would mean they would be able to tolerate holding higher levels of
debt in order to maximize the value of their leveraged firms.

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 References
Daniel Da Costa (2020, June 24). Telecom Stocks: Shaw (TSX:SJR.B) vs. Telus (TSX:T). Which Is the
Better Buy? The Motley Fool Canada. https://www.fool.ca/2020/06/24/telecom-stocks-shaw-
tsxsjr-b-vs-telus-tsxt-which-is-the-better-buy/.

TELUS Corporation. 2020 Annual Report. (n.d.). Retrieved from

https://sec.report/Document/868675/000110465921062749/tm2111623d1_ex99-2.htm

TIKR: Institutional-grade investing for Individuals. TIKR Terminal. (n.d.).

https://app.tikr.com/stock/transcript?cid=598689&tid=141548649&ts=2276517&e=71121765
7&refCode=rg7bgk&ref=i18e1f.

TIKR: Institutional-grade investing for Individuals. TIKR Terminal. (n.d.).

https://app.tikr.com/stock/transcript?cid=109300&tid=2650012&ts=2168770&e=690180172
&refCode=rg7bgk#.

Shaw Communications Inc. 2020 Annual Report. (n.d.). Retrieved from

https://sec.report/Document/0001193125-21-116442/

Yahoo! (2021, June 19). SHAW COMMUNICATIONS INC., CL.B, (SJR-B.TO) Stock Price, News, Quote &
History. Yahoo! Finance. https://ca.finance.yahoo.com/quote/SJR-B.TO?p=SJR-B.TO&.tsrc=fin-srch.

Yahoo! (2021, June 19). TELUS CORPORATION (T.TO) Stock Price, News, Quote & History. Yahoo!
Finance. https://ca.finance.yahoo.com/quote/T.TO?p=T.TO&.tsrc=fin-srch.

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