Академический Документы
Профессиональный Документы
Культура Документы
The market value of equity is also referred to as market capitalization. To calculate the market value of equity, multiply the total
number of shares outstanding by their current price per share
Calculating the
Weighted Average Cost of Capital (WACC)
for a Company
For use in Conjunction with the Firm Valuation Project
First ensure that you have read relevant pages in the text. Some important sections
would include the following, but you may also double-check the references in the
text by using the index [see: Cost of Capital and Target (optimal) Capital
Structure, etc.]:
The important Chapter in the text is the one entitled "The Cost of
Capital," with a particular focus on the section entitled The Weighted
Average Cost of Capital and the section Four Mistakes to Avoid at the
end of the chapter.
The WACC formula discussed below does not include Preferred Stock. Should
your company use PS, be sure to adjust the equation for it, and see the section in
the chapter on the Cost of Preferred Stock.
The WACC formula that we use is:
WACC = wdrd(1-T) + wsrs
We need to know how to calculate:
1. rs the cost of common equity. Use the Security Market Line (SML) this
is why you learn how to calculate a companys beta and also why you learn
how to find the appropriate risk-free rate and market-risk premium. For a
review, see the section the text, The CAPM Approach.
2. The weights (wd and ws note that: wd + ws = 1; so you only have to
calculate one of them). We need to calculate the weight of debt and the
weight of equity (for the cost of debt, this simply means: what proportion of
the firms financing is by debt?). There is a lot to say here, simplified as
Theory 1, Theory 2 and Practice:
a. Theory 1: Theory says that we should use the target weights along
with the market values of both debt and equity (see the Four
Mistakes to Avoid). But the market value of debt is typically difficult
to calculate, because we need to know the YTM (which is r d) for all of
the companys debt, but we cannot calculate the YTM without having
the current prices of the companys outstanding bonds, and most
companys bonds do not trade (i.e., they will not have up-to-date or
current prices remember how to calculate the price (value) of a bond
on your calculators?!). As a result, at least for the group project, we
go
to
Theory
2.
b. Theory 2: Theory also says that we should use the TARGET weights,
but this is a management decision, and as outsiders we do not have
out the following steps (if you cannot find a bond rating for your company,
you might try to estimate/guess what it is by considering your companys
beta and comparing the bond ratings for companies with similar betas). If
you are not able to find a bond rating readily, you can register (for free)
at Standard & Poor's and at Moody's to find company ratings. You may also
find other interesting and useful information there. For a general discussion
of what the ratings mean, see the information from these rating agencies on
my
homepage
at
the Bond
Rating link.
Once you have the actual bond rating or an estimate you can then find or
estimate your companys cost of debt by going to Yahoo.finance and
clicking on theBonds/Rates link (http://bonds.yahoo.com/rates.html). Look
at the yields for the 20 year Corporate Bonds by rating. If your companys
bond rating is listed, youre in luck. If it is not listed then you can estimate
the cost of debt. For example, if the AAA yield is 6.50%, the AA yield is
6.75% and the A yield is 7.00%, you can see a pattern (equation). For every
increase in risk (from AAA to AA), there is a 0.25% increase in the yield. If
your company has a BB rating, then it is two steps below the A rating, so
you should add approximately 0.50% more to the 7.00% for the A rating,
giving you a cost of debt for your company of about 7.50%. Note that this
approach assumes a linear equation for the cost of debt (which may not be
strictly true).
4. The corporate tax rate ( T ). Be sure to read the section in the text on
Corporate Income Taxes (Chapter 2). The correct tax rate for a company is
themarginal tax rate for the future! If you expect your company to be very
profitable for a long time into the future, then the tax rate ( T ) for your
company should probably be the highest marginal tax rate applicable for
corporations. But there are times when companies can obtain long-term tax
breaks so that their tax rates may be lower than the stated (regulated) tax
rate. Consequently you may want to calculate several/many
historical effective tax rates for you company. The effective tax rate is the
actual taxes paid divided by earnings before taxes (on the income
statement). You can calculate/consider these rates for the past 5-10 years
and then compare this effective tax rate to the legally mandated highest
marginal corporate tax rate. If the past historical effective rate is lower than
the marginal tax rate, there may be a good reason for using that lower rate in
your pro formas.