Share
Explore BrainMass

Weighted Average Cost of Capital (WACC)

The weighted average cost of capital (WACC) is the cost of financing for new projects found by looking at the firm's financing options, both debt and equity, as a fixed basket. When a firm undertakes a new project, it typically finances the project with one source of financing: either cash, debt or equity. However, we know that in practice most firms have a target capital structure. That is, using debt this time will reduce the firm's debt capacity, and they will likely raise equity next time. If we use cash this time, it has a related opportunity cost.

We therefore use the firm's target capital structure as representing the fixed mix of debt and equity of the firm over the long-term (even if it varies in the short-term). We typically exclude short-term liabilities when comparing our debt to equity when the firm's short-term liabilities do not reflect the firm's permanent financing (for example, accounts receivable and a short-term line of credit would be excluded because they reflect sales or seasonal needs, not permanent financing needs). However, if a short-term bank loan was used as part of the firm's permanent capital structure, it would be included. 

The unadjusted weighted average cost of capital is equal to the cost of equity times the proportion of the firm's capital strucutre composed of equity, plus the firm's cost of debt times the proportion of the firm that is financed with debt. 



Where,
r= the rate of return on equity
r= the rate of retun on debt
S/(S+B) = the proportion of the firm financed with debt
B/(S+B) = the proportion of the firm financed with equity

The adjusted weighted average cost of capital takes into account the fact the interest rate payments on debt are typically tax deductible, and thus the after-tax cost of debt is what we need to compare with the cost of equity (which is inherently after tax), and after-tax cash flows when using WACC to value a project. 



The weighted average cost of capital (WACC) can be used in a net present value (NPV) analysis as the rate of return required for a project undertaken by a levered firm. 

Stock Valuation, Floatation Cost, Total Return, CAPM & WACC

The following need worked out. Please show calculations. 1. Stock Valuation: A stock has an initial price of $100 per share, paid a dividend of $2.00 per share during the year, and had an ending share price of $125. Compute the percentage total return, capital gains yield, and dividend yield. 2. Total Return: You bought a

Calculating levered and unlevered cost of equity

Weston Industries has a debt-equity ratio of 1.1. Its WACC is 8.2 percent, and its cost of debt is 6.4 percent. The corporate tax rate is 35 percent. a. What is Weston's cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Agency Costs & Expected Value of a Firm

Sheaves Corporation economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The manager of Sheaves must choose between two mutually exclusive projects. Assume that the project Sheaves chooses will be the firm's only activity and that the firm will close one year

Calculating the Exercise Value of a Warrant

All work must be shown in Excel with breakdown of how you derive at solution. 1. Breuer Investment's convertible bonds have a $1,000 par value and a conversion price of $50 a share. What is the convertible issue's conversion ratio? 2. Maese Industries Inc. has warrants outstanding that permit the holders to purchase 1 sha

Calculations for the WACC of a Company

1. You need to estimate the equity beta for Golden Clothiers, Inc. Golden's debt-to-equity ratio is 85%, which is higher than a typical firm in its industry. The following table shows the levered equity betas and debt-to-equity ratios for three comparable chemical firms. Assume the tax rate is 40%. (See attached file for d

Weighted Average Cost of Capital Definition and Example

Capital is one of the most important resources for business firms. It is important for managers to be aware of their cost of capital. To determine cost of capital, an important concept is weighted average cost of capital. Define Weighted Average Cost of Capital (WACC). How WACC is calculated ? Take an example of a large

WACC, Required Return on Equity, CAPM, IRR & Present Value

WACC: Common stock of the company KewCo. has a beta of 1.3. Treasury Bills provide a return of 4% and the market risk premium is 16%. Suppose KewCo. total value is composed of 60% equity and 40% debt (by market value). Debt yields of 8%. There are no shares of preferred stock in circulation. a. Find the cost of equity capita

Practice Quiz- 10 Questions

Question 1) Why WACC cannot be used as a discount for calculating the value of a merger and acquisition for the first few years of the analysis? Question 2) When calculating the value of a target for acquisition, why do different acquirers arrive at different valuations for the target? Question 3) Calculate the cost of

TESCA - Find Cost of Equity

Please answer only these 2 questions. 1. How much importance should be given to the energy cost situation? 2. What is the project's cost of equity? Tesca Works Introduction Michael Burton has recently been hired as the CEO of Tesca Works, Inc. Previously he had been the marketing manager for a large manufacturing co

WACC Component Calculations

A Company has the following sources of financing reported on its balance sheet: Liabilities & Equity Debt (13% coupon bonds, $1000 face value)--> Book Value= $4,000,000 Common stock, 100,000 shares--> Book Value=$6,000,000 Total $10,000,000 The bonds are currently selling for $900, and have a yield-to-maturity of 15%

WACC Concept and Discussion

a. What is Weighted Average Cost of Capital (WACC)? Identify TWO (2) factors that affect the WACC of a company. 1- Using debt can help reduce the agency problem that may arise between the management of a company and its shareholders. Explain. 2- Explain the effects of the following on the company's weighted averag

AMAZON.com: Weighted Average Cost of Capital (WACC)

Please show work and calculations. Estimate the components of the cost of capital for AMAZON using MARKET data: (a) For the cost of common stock, analyze using the dividend growth model and beta estimate using the dividend growth model and CAPM. To determine Beta, first use published sources. Next calculate your own beta e

Capital Budgeting and Cost of Capital

1. A project has an up-front cost of $100,000. The project's WACC is 12 percent and its net present value is $10,000. Which of the following statements is most correct? a. The project should be rejected since its return is less than the WACC. b. The project's internal rate of return is greater than 12 percent. c. The projec

Target Capital Structure (WACC)

Suppose Bianca's target capital structure is as follows: Wd=0.40 Wps=0.10 Wce=0.50; Its before-tax cost of debt is 8.0%, cost of equity is 12.0%, cost of preferred stock is 8.4%, and the marginal tax rate is 40%. Calculate Bianca's Weighted Average Cost of Capital (WACC). Please show your work so I can understand ho

The Cost of Capital: Debt or Equity?

Cost of Capital: Debt or Equity? 1) What your opinion on JUSTIN's ANSWER to the question below? JUSTIN's ANSWER: The pecking order theory addresses how companies will choose to finance in a certain order if given the option. (Frank & Goyal, 2007) First, they will choose to finance with internal funds. Next, they will cho

Lucent WACC Calculation

Suppose Lucent has cost of equity of 9%, equity market capitalization of $10 billion, and total debt 4 billion and 0.4 billion of excess amount of cash. Suppose Lucent's cost of debt is 6% and its marginal tax rate is 35% (Note: Use Net Debt concept (ND) and leverage ratio = ND/(ND+E)). #Question 3.1: What is Lucent's WACC

Weighted Average Cost of Capital - WACC Calculation

A company is funded equally by debt and equity and investors expect 12% per annum return from investing in the firms equity and 4% (net of tax) per annum to invest in its debt. What is the firms WACC? If the firm suffers a credit downgrade and investors require a return of 6% (net of tax) what is the new WACC? Also, how does

Determining Firm Beta Given Equity Capital and Marginal Tax Rate

The cost of equity: RadicalVenOil, Inc., has a cost of equity capital equal to 22.8 percent. If the risk-free rate of return is 10 percent and the expected return on the market is 18 percent, then what is the firm's beta if the firm's marginal tax rate is 35 percent? Please show step-by-step work up. I'm using a TI BA II PLUS

Cost of Debt Before and After Taxes

Problem 1 A company issues 15-year, $1,000 par-value bonds, with a coupon rate of 5%. The bonds are sold for $619.70. The tax rate is 30%. Compute the cost of debt before taxes and after taxes. Problem 2 Suppose a company issues common stock to the public for $25 a share. The expected dividend is $2.50 per share and t

Financing and Valuations

Interest tax shield benefit: Legitron Corporation has $460 million of debt outstanding at an interest rate of 10 percent. If Legitron is subject to a 37 percent marginal tax rate, the amount of the tax shield on that debt for this year is $ . (Round answer to nearest dollar. Omit $ sign in answer.) M&M Proposition 1:

Capital Budgeting Principles

1) Each of the following investment opportunities would cost $55,000. Using the following information, calculate the payback period for each proposed investment. In addition, which project would you select based on the payback method of analysis? Why? Finally, what short comings do you see with the payback method of analysis

Bloomington Clinics Practice Valuation

Write a 500 word case analysis for Case 24 using the case study and spreadsheet information. Bloomington Clinics Practice Valuation Case Study. HAP, 2010. BLOOMINGTON CLINICS Practice Valuation This case illustrates the valuation of a medical practice, including cash flow estimation and the use of bot

Weighted Average Cost of Capital Determination

This solution discusses the case study 'BCB Sports: Cost of Capital (WACC)', prepared by Dr. D. M. Lander and B. Bouchard, in 2007. The case study necessitates the use of the following formula: WACC = D/V (Rd) (1-Tc) + E/V (Re) and I can use the WACC formula because this company has both debt and equity. Please advise

Financial Statement Analysis for Bulls, Inc.

Listed below is financial information for Bulls, Inc. Total Assets $38,673 Book value of debt $11,258 Average borrowing cost 10% Common Equity: Book Value $21,489 Market Value $42,698 Margina

Optimal Capital Structure and Average Cost of Capital

The Cost of Capital Canyon Drilling, Inc. has just come under new management. One of the first things the new management wants to accomplish is to identify its capital structure and the cost of additional funding, if needed. According to the accounting department, the current balance sheet is accurate and reflects the financ

Financing and Valuation

M&M Proposition 1: Marx and Spender has a current WACC of 23 percent. If the cost of debt capital for the firm is 9 percent and the firm is currently financed with 48 percent debt, the current cost of equity capital for the firm is ____%. Assume that all the assumptions of Modigliani and Miller Proposition 1 hold.