Company Cost of Capital
The cost of capital reflected the average cost of raising funds for the company at a given point in time which fluctuated as the cost of primary sources of finance such as debt and equity changed. The company therefore periodically reviewed its estimate of the cost of capital which was reflective of market conditions.
Cost of debt
Domino’s followed several approaches in estimating the company cost of debt. The approach(es) employed was what the analyst team believed most accurately reflect the cost of borrowing for the company in the current market conditions or in the near future based on available information.
1. Historical cost of debt
Where there were material reasons for the team to believe that the cost of borrowing would not change significantly in the future, for example stable macroeconomic indicators and immaterial changes in the company’s earnings and debt servicing outlook, the historical cost of borrowing could be used as the basis for the cost of debt estimate. It was also a common practice for the company to consider only the cost of long-term borrowing in the cost of debt projection.
The company’s latest balance sheet as of 02 July 2023 was detailed in Exhibit 1. As of this date, Domino’s total long-term borrowing was approximately $979 million.
| 2023 ($'000) | 2022 ($'000) | |
| Assets | ||
| Current Assets | ||
| Cash and cash equivalents | 159,891 | 76,877 |
| Trade and other receivables | 176,208 | 163,591 |
| Other financial assets | 36,642 | 20,892 |
| Inventories | 43,120 | 30,861 |
| Current tax assets | 43,370 | 1,234 |
| Other assets | 52,640 | 45,760 |
| Investment in lease assets | 78,179 | 72,063 |
| Total Current Assets | 590,050 | 411,278 |
| Non-Current Assets | ||
| Other financial assets | 108,934 | 119,869 |
| Investment in joint venture | 1,742 | 1,709 |
| Property, Plant and Equipment | 324,658 | 273,471 |
| Deferred tax assets | 498 | - |
| Goodwill | 551,644 | 485,707 |
| Intangible assets | 638,911 | 450,352 |
| Right of use assets | 297,077 | 306,845 |
| Investment in lease assets | 365,934 | 382,493 |
| Total Non-Current Assets | 2,289,398 | 2,020,446 |
| Total Assets | 2,879,448 | 2,431,724 |
| Liabilities | ||
| Current Liabilities | ||
| Trade and other payables | 378,992 | 303,976 |
| Contract liabilities | 3,518 | 3,134 |
| Lease liabilities | 141,408 | 122,304 |
| Borrowings | - | 32,035 |
| Other financial liabilities | 14,503 | 140,003 |
| Provisions | 31,444 | 21,559 |
| Current tax liabilities | 24,241 | 17,571 |
| Total Current Liabilities | 594,106 | 640,582 |
| Non-Current Liabilities | ||
| Borrowings | 978,591 | 612,066 |
| Contract liabilities | 12,416 | 15,775 |
| Lease liabilities | 619,937 | 646,714 |
| Other financial liabilities | 18,327 | 511 |
| Provisions | 16,759 | 8870 |
| Deferred tax liabilities | 118,795 | 85,249 |
| Total Non-Current Liabilities | 1,764,825 | 1,369,185 |
| Total Liabilities | 2,358,931 | 2,009,767 |
| Net Assets | 520,517 | 421,957 |
| Equity | ||
| Issued capital | 430,476 | 264,212 |
| Reserves | -126,109 | -136,848 |
| Retained earnings | 216,150 | 294,593 |
| Total Equity | 520,517 | 421,957 |
Exhibit 1 – Consolidated Balance Sheet as of 02 July 2023
Source: DMP’s 2023 Annual Report
The notes to the 2023 financial statements further revealed that the company’s long-term borrowing was in the form of a bank loan that attracted an effective interest rate of 2.08% per annum as shown in Exhibit 2. This interest rate reflected a historical borrowing rate.
Exhibit 2 – Interest rate on Financial Liabilities
Source: DMP’s 2023 Annual Report
The implied cost of debt for a particular year could also be estimated using the interest expenses incurred by the company. In this instance, the cost of debt was calculated based on the following formula:
[latex]Cost\ of\ debt\ (Rd)=\frac{Interest\ on\ loans}{Total\ borrowings}[/latex]
Notes 5 to the financial statements of DMP’s 2023 Annual Reports disclosed the interest expense as detailed in Exhibit 3. As the company did not carry any short-term debt (i.e commercial bills) as of reporting date, the interest on commercial bills and loans referred to in Exhibit 3 primarily related to the bank loans.
Exhibit 3 – Finance costs
Source: DMP’s 2023 Annual Report
2. The risk-free rate plus a credit spread
While the use of a historical cost of debt as a proxy for the company’s current or future cost of debt was a convenient approach, a major issue with this approach was it may not be reflective of current market conditions. When there were material changes in market conditions such as a sharp increase or decrease in the risk-free rate or the credit risk of the company, a different methodology was required.
A common approach to estimating the cost of debt that was adopted by Domino’s from time to time to overcome this issue was the use of a risk-free rate plus a credit spread. The logic behind this approach was that a company’s cost of debt was equal to the risk-free rate plus a credit spread that reflected the credit worthiness of the business. The higher the credit rating (i.e the lower risk of default), the lower the credit spread. Hence, businesses with higher credit ratings were able to raise funds at lower costs, other things being equal.
As a reference, as of December 2023, Australian BBB-rated corporate bonds attracted a borrowing cost of 5.43% per annum as shown in Exhibit 4. This represented a 0.25% decrease from June 2023.
| Indicator rates | Jun-23 | Dec-23 | Change |
| Corporate bonds (BBB 10 years) | 5.68% | 5.43% | -0.25% |
| Credit spread | 1.66% | 1.47% | -0.19% |
Exhibit 4 – Corporate borrowing rates for 10-year BBB-rated bonds
Source: S&P Capital IQ
3. RBA’s business rates
The Reserve Bank of Australia (RBA) compiled business lending rates from banks and registered financial corporations which could also be used as a proxy for the cost of debt. The business rates reported by the RBA were the weighted average interest rates reported by lenders for various business sizes. A small business was defined as having a turnover of less than $50 million and total liabilities of less than $1 million. A medium business had total liabilities of more than $1 million with turnover of less than $50 million. All other businesses with turnovers of more than $50 million were classified as large businesses.
Exhibit 5 illustrated the business lending rates in Australia for different sized businesses in the last 4 years. As of November 2023, the applicable lending rate to large businesses was 5.71% per annum (7.09% per annum for a small business). The data updated monthly, and Domino’s considered the use of the most up to date data the best practice.
Exhibit 5 – Outstanding Business Lending Rates
Source: Lenders' Interest Rates | RBA
