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GE Financial Analysis: WACC, Cost of Debt, and Cost of Equity

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Please provide in-depth solutions to the financial calculations based on the attached spreadsheet.

Calculate the cost of each capital component, after-tax cost of debt, cost of preferred, and cost of equity with the DCF method and CAPM method.

Estimate the company's WACC.

Some notes on the calculations:

Calculating WACC is probably the most challenging quantitative part of the project. You need to calculate it for all 3 years. If it differs very much from year to year, then you must make a decision as to what you think it will be in future years.

Here are some suggestions that may help:

COST OF DEBT:

For pre-tax cost of debt, divide interest expense on the income statement by interest bearing debt on the balance sheet (short-term debt, current installment of long-term debt, and long term debt).

For after-tax cost of debt, first divide provision for taxes on the income statement by earnings before taxes to get the tax rate. Then multiply the before tax rate by 1 minus the tax rate to get after-tax cost of debt.

COST OF EQUITY:

DCF approach: Estimate the growth rate and next annual dividend. Of course, if your company doesn't pay a dividend, that doesn't work.

CAPM approach: Use the long-term t-bond rate for the risk-free rate and the S&P 500 index (or another index) returns for average return on the market. It's okay to use the current beta for all years.

You might want to supplement the DCF and CAPM with the company's (or a similar company) long bond rate plus a premium.

Keep in mind that cost of equity will ALWAYS be higher than cost of debt or preferred stock because the risk is greater. If cost of equity comes out lower using these guidelines (usually because of net loss), use judgment in determining cost of equity.

COST OF PREFERRED STOCK:

Most companies don't have preferred stock, but if they do:
Divide the annual dividend by the stock price

PUTTING IT ALL TOGETHER:

Determine the proportion of each capital component in the capital structure
o divide each component by total capital.
Multiply the proportion of each type of capital by its cost.
Combine to determine WACC.
Finally, determine the WACC you think should be used for upcoming capital needs.

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Solution Summary

This solution provides a complete computation of the given finance problem formatted in Excel.

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Answer: Given that,
After-tax cost of debt calculations:
For Before tax cost of debt calculations: For total debt calculations:
Year 2010 2009 2008 Year 2010 2009 2008
Interest Charges 15,983 18,769 26,209 Short Term Borrowings 117,959 133,054 193,695
Interest bearing debt 478,640 510,192 523,762 Non-recourse borrowings of consolidated securitization entities 30,060 - -
Before tax cost of debt 3.34% 3.68% 5.00% Bank Deposits 37,298 38,923 -
Long term borrowings 293,323 338,215 330,067
For tax calculation: 478,640 510,192 ...

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  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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