Finance Advance Finance Interim report Assignment 2015

| January 30, 2017

Question
What do you estimate the company’s WACC?

Be sure to do all calculations for 3 years, using Excel. Use real numbers from the financials, not reported ratios provided by online and other sources. Show the source of the numbers.

Instructions:

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. You can use the 5-year annual growth rate for g. A good source is.bloomberg.com/quote/eat:US”>http://www.bloomberg.com/quote/eat:US. (Just overlay eat in the url with the symbol for your company). Of course, if your company doesn’t pay a dividend, you can’t use this approach.

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. A good source for t-bond rates is.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield”>http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield. A good source for the S&P 500 index is.1stock1.com/1stock1_141.htm”>http://www.1stock1.com/1stock1_141.htm.

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

Cost of preferred stock isn’t relevant if company doesn’t have preferred stock.

PUTTING IT ALL TOGETHER:

• Determine the proportion of each capital component in the capital structure, then
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.

The above should at least give you a good start.

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