WACC

The Weighted - Average Cost of Capital and Company Valuation

COST OF CAPITAL - the return the firm's investors could expect to earn if they invested in securiti
CAPITAL STRUCTURE - is the mixture of long-term debt and equity financing

EXAMPLE: GEOTHERMAL INC.

Issued 22.65 million shares that are now trading at $20 each.
Therefore, the equity is 20*22,65
The company has issued bonds with a current market value of $194 million.
Total market value is 194+453=647 million dollars
Debt was 30% of the total market val

Debt financing means issuing bonds.

THEREFORE
Market value of debt 194 30%
Market value of equity 453 70%
Market value of all assets 647 100%

Debt yielding 8
equity 14

PORTFOLIO RETURN 12.2009273570325

(.3 × 8%) + (.7 × 14%) = 12.2%

The company cost of capital is just a WEIGHTED AVERAGE OF RETURNS ON DEB

with weights depending on relative market values of the two securities.

However, interest is TAX-DEDUCTABLE.

So, given a tax rate of 35%, debt only costs the company 5,2%.
0,65*35%=5,2%
(100-35%)

THEREFORE WACC CAN BE CALCULATED 11.36

WACC = (.3 × 5.2%) + (.7 × 14%) = 11.4%

13.02 WACC - WEIGHTED AVERAGE COST OF CAPITAL

THE EXPECTED RATE OF RETURN ON A PORTFOLIO OF ALL THE FIRM'S SECURIT
ADJUSTED FOR TAX SAVINGS DUE TO INTEREST PAYMENTS
Company cost of capital = Weighted average of debt and equity returns

𝑟assets = total income / value of investments

Value is made of Debt + Equity, D=debt, E=Equity, V= total value of D+E combin
D = market value of debt
E = market value of equity = number of shares × price per share

After-tax cost of debt = pretax cost × (1 - tax rate) = Rdebt × (1 - Tc )

FINAL FORMULA:

WACC = (D/V * (1-Tc) Rdebt) + (P/V * Rpreferred) + (E/V * Requity)

E=Market value of the firm’s equity
D=Market value of the firm’s debt
V=E+D
Re=Cost of equity
Rd=Cost of debt
 Tc=Corporate tax rate

Three Steps to Calculating Cost of Capital

1. Calculate capital structure using market value weights
2. Determine the required rate of return on each security
3. Calculate a weighted average of the after-tax return on the debt and the re

Rd = debt
Tc = Tax rate

AFTER TAX COST OF DEBT = (1-tax rate) * pretax cost = (1-TC)*Rdebt

EXAMPLE 13.1 STEP 1:

V=D+E $ 51,807.00
Debt D/V 0.16
Equity E/V 0.84
as proportion of the total

STEP 2:
Requity Required rate of return 11.3
Rdebt Yield 5.3

STEP 3:
WACC = (D/V * (1-Tc) Rdebt) + (E/V * Requity)
WACC = (0,16 * (1-0,35)*5,3) + (0,84*11,3)
10.04

EXAMPLE Executive Fruit has issued long-term bonds with a market value of $50 million a
It has 4 million common shares outstanding trading for $10 each. At this price,

Long term bonds - Debt - 50 million Rdebt - 9%

Shares - Equity - 4 million * $10 = $40 million Requity - 17%

The company pays no taxes

Therefore,
Step 1: V=D+E 90
D/V 56%
 E/V 44%

Step 2:
Required rate of return - Requity 17%
Expected return - Rdebt 9%

Step 3:
WACC = (D/V (1-Tc) * Rdebt) + (E/V * Requity)
0.126

Companies often run their business using the capital they raise through various sources.
They include raising money through listing their shares on the stock exchange (equity), or by issu
All such capital comes at a cost, and the cost associated with each type varies for each source.

RETURNS
EXAMPLE DEBT 4 6
PREFERRED STOCK 2 12
COMMON STOCK 6 18
Tc 35%

Step 1:
V=D+E 12 FIRM VALUE
D/V 0.33
Common stock 0.50
Preferred stock 0.17

Step 2:
Rdebt 6
Requity 18
Rpreferred 12

Step 3:
WACC = (D/V * (1-Tc) Rdebt) + (P/V * Rpreferred) + (E/V * Requity)
12.3 or 12,3%

Example 3 Asset book value 75

SELF-TEST 13.2 Liabilities: 75
Debt 25
 Equity 50

6 million shares per $4 24 equity

Debt 20
20% of 25
5

Step 1:
V=D+E 44 FIRM VALUE
D/V 45%
E/V 55%

Step 2:
Rdebt 14
Requity 20

Step 3:
WACC = (D/V * (1-Tc) Rdebt) + (P/V * Rpreferred) + (E/V * Requity)
17.3

if the tax is 35%

WACC = (D/V * (1-Tc) Rdebt) + (P/V * Rpreferred) + (E/V * Requity)

15.05

SELF-TEST 13.3 EBIT 10

Interest payment 2
Corporate tax rate 35%

ABC INC ABC INC WITHOUT DEBT

Income statement
EBIT 10 10
Interest payment 2 0
EBT 8 10
Taxes 2.8 3.5
Net Income or profit after tax 5.2 6.5
Total income from debt and equity 7.2 6.5
debt no debt

EXPECTED RETURN ON PREFERRED STOCK

PRICE OF PREFERRED STOCK P0 = DIV1/Rpreferred

Solve for Rpreferred: Rpreferred = DIV1/P0
f they invested in securities with comparable degrees of risk

453.00 in millions
value of $194 million.

of the total market value.

GE OF RETURNS ON DEBT AND EQUITY,

he two securities.

ALL THE FIRM'S SECURITIES,

and equity returns

otal value of D+E combined.

ebt × (1 - Tc )

V * Requity) WACC with preferred stock

n on the debt and the return on the equity

= (1-TC)*Rdebt

ket value of $50 million and an expected return of 9%.

$10 each. At this price, the shares offer an expected return of 17%.
various sources.
hange (equity), or by issuing interest-paying bonds or taking commercial loans (debt).
varies for each source.

V * Requity)
V * Requity)

V * Requity)

WITHOUT DEBT
1 t
2 t
3 t
4 f
5 b
6 debt ratio=? D= 15
V= (15+35)
D/V = 0.3 I.E 30

7 WACC = (D/V * (1-Tc) Rdebt) + (E/V * Requity)

65/35 DEBT/EQUITY
Debt 65 8%
Equity 35 15%
Total 100
tax rate 35%

8.63

8.
Pretax Rd 15.38
After-tax Rd = Pretax Rd * (1-Tc)

9. Tc 35%
Rpreffered ?
Selling price 10
Dividend 1.2

Rpreferred = Div1/P0 = 1,2/10 = 12%

10. common stock 55% 15%

preferred stock 10% 10%
debt 35% 8%
Tax rate 35
WACC 11.07%
V=D+E 100
D 35
Common 55
Preferred 10

Rdebt 15
Rcommon 10
Rpreferred 8

11. Investment 10 million

Cash flow 1,250,000 annual
WACC 12.50%
Project is riskier than the firm's average projects, should it be accepted?

NPV=?
0
D
The 12.5% rate does not reflect the project's greater risk, so NPV is negative

12. tax rate 35% CASH FLOW BEFORE TAX AND IN

common stocks 13
debt (bonds) 6 V=D+E
D/V
E/V

EBIT 2.36
Interest payment 0.36
EBT 2
Taxes 0.7
Net Income or profit after tax 1.3

Requity 10%
Rdebt 6%

ANSWER - C

13. D
Book value Market value
14. common stock 12000 20 39
preferred stock 5000 22 26
debt 400000 87% at par
 Equity 468000
Preferred 130000
Debt 348000

V=D+E+P 946000
D/V 36.8%
E/V 49.5%
P/V 13.7%

15. rate of return 9%

market value 54
Rp = Div1/P0 Div1 = Rp*P0
4.86
The dividend paid is 4,86

16. WACC 18.60%

Debt-to-equity ratio 0.25
Pre-tax cost of debt 9.40%
Cost of common equity ?
Tax rate 34%

DV (1+4)/5 1 1/5
EV 4/5
WACC = we exchange in the formula

18,6% = (0,20 * 0,094(1-0,34) + (0,80*Requity)

18,6% = 1,24*0,80*requity
0,80Re = 17,36
Requity 21.7

18. WACC 14%

After tax cost of debt 7%
Tax rate 35%
Required rate on equity 18%
 Equity - ?

D/V =?
E/V =1-X

0,14 = ((1-x)*0,07) + (x*0,18)

0,14 = 0,07 - 0,07x + 0,18x
0,07 = 0,11x
x = 0,07/0,11 ?
0.63636364 E/V

0,14 = (x*(1-0,35)*7) + (x*18%)

19. cash flows

Y1 148.000
Y2 128.000
Y3 65.000

Cost of equity 15.50%

After-tax cost of debt 6.20% Ako imame deka debt t
PV of the firm if debt to value ratio is 30% se podrazbira deka equ

WACC 12.7%
NVP $ 277.47 Presmetano so funkcija NPV
Inaku PV = $148,000 / 1.1271 + $128,000 / 1.12712 + $65,000 / 1.127

20. equity proportion ?

debt 50 million @ 85%
equity 65 million market value of equity

Debt 42.5
V=D+E 107.5
E 65
E/V 60.5%
21. Cost of equity ?
Beta 1.5
Rf 6% 6%
Rm 15%

Expected return CAPM = 20%

23. YTM ?
After tax cost of debt 10%
Tax rate 35%

0.10 = Rd(1 − 0.35)

Rd = 15,38%
hould it be accepted?

r risk, so NPV is negative.

OW BEFORE TAX AND INTEREST (EBIT)

19
0.32
0.68

Interest payment odi so bonds

0,35/0,65*1,3
13million*10%

Market value
Ako imame deka debt to value ratio e 30%,
se podrazbira deka equity e ostanation 70%

12712 + $65,000 / 1.12713 = $277,467

2 Beta of common stock 1.2
T-bill rate 4%
Market risk premium 7.50%
YTM on long-term debt 6%
Book value of equity 440
Market value of equity 880
Long-term debt outstanding 880
Corporate tax rate 35%
FIND WACC

A First, we calculate the expected return on the common stock

Expected rate of return 13%

B WACC
Step 1: V=D+E 1760
D/V 0.5
E/V 0.5

Step 2: Requity 13% required or expected rate of return is st

Rdebt 6% yield bond

Step 3: WACC
8.45%

7. WACC. Look at the following book-value balance sheet for University Products Inc.
Preferred stock currently sells for
dividend
Common stock market risk premium
Rf
Corporate tax rate
a) Calculation of the market debt to value ratio of the firm
Step 1: Calculating Market value of Bond
C=10mill*0,08 0.8
 1 1  $10 mil
PV or Market value of bonds  $0.8 mil    10 

 0.09 0.09(1.09)  1.0910

Step 2: Calculating Market Value of Preferred stock

Market value of preferred stock = Number of outstanding preferred stock *
Market value of preferred stock = 1500000

Step 3: Calculating Market value of common stock

Market value of common stock = 1
Market value of common stock = 20

Step 4: Calculating TOTAL VALUE of firm

Market value of debt 9.36
Market value of preferred stock 1.5
Market value of common shares 20
Total market value of the firm 30.86

Step 5: Market (Debt/Value) 30.3%

b) WACC
 Step 1 D/V 30.3%
E/V 64.8%
P/V 4.86%
V=D+E+P 100.0%

Step 2 Rdebt 9% R-debt=YTM

Requity 14% CAPM
Rpreferred 13% Rpreferred = Div1/P0

preferred stock price

preferred stock dividend
P0 = current price of the stock, current s

Step 3 WACC
11.4%

21) Preferred stock outstanding

Dividend 4 dollars per share
Current price 40 dollars
Corporate tax 35%
% cost of preferred stock?

Cost of preferred stock 0.1 10

D/P in percentage is 10%
Dividend / Price

24) return
debt 30% of the pv 6%
equity 70% 11%
OCF 68
Investment in plant and net w-capital 30
Growth per year (perpetuity) 4%
Tax rate 40%
a. What is the total value of Icarus?
CALCULATE WACC
Step 1: D/V 0.3
E/V 0.7
V=D+E 1

Step 2: Rdebt 6%
Requity 11%

Step 3: WACC
8.78%

CALCULATE FCF:
FCF = Operating cash flows - Investment in expenditures (fixed assets) and net working cap
FCF = 38

CALCULATE TOTAL VALUE OF THE COMPANY

Value of the Company = or FCF/(r-g)

$ 794.98

b. What is the value of the company's equity?

Equity 70%
Debt 30%
Total 100%

E/V $ 556.49
 D/V $ 238.49

So, the Value of the company $794,97 million is actually $556.47 million equity and $238.4

25) 1 2 3
EBITDA 80 100 115
Depreciation 20 30 35
Pretax profit 60 70 80
Tax at 40% 24 28 32
Investment 12 15 18

Financing Debt 50%

Equity 50%

Rdebt 7%
Requity 15%
Corporate tax rate 40%

*EBITDA = Earnings before interest, taxes, depreciation and amortization

A) CALCULATE WACC
Step 1: D/V 30%
E/V 70%
V=D+E 1

Step 2: Rdebt 7%
Requity 15%

Step 3: WACC
9.60%

CALCULATE FCF:
FCF = Operating cash flows - Investment in expenditures (fixed assets) and net working cap

1 2 3
EBITDA 80 100 115
 Depreciation 20 30 35
Pretax profit 60 70 80
Tax at 40% 24 28 32
Net Income 36 42 48
OCF (NI+D) 56 72 83
Investment 12 15 18
FCF 44 57 65

CALCULATE HORIZON VALUE

HORIZON VALUE = FREE CASH FLOW IN YEAR 6 / R-G
Horizon value = 68/0,096
$ 708.33

CALCULATE PV OF THE BUSINESS

(Which is the discounted FCF until the Horizon Year and the predicted value at the horizon
PV =

PV= 40.146 ден

47.452 ден
49.372 ден
47.127 ден
$ 490.90 na 4ta
PV = 675.00 ден

B) What is the value of Laputa's equity?

Equity 50%
Debt 50%
VALUE 675.00 ден

D/V 337.50 ден

E/V 337.50 ден
 sega go ima Requity

rate of return is stock

oducts Inc.
$15
$2 a share
10%
6%
40%
 1  $10 mil
10 
  $9.3582 mil
09(1.09)  1.0910

g preferred stock * Market value per preferred stock

2 million

1 million
million

it's not multiplied by 2 dolalrs because It says that it currently

sells for 15 dollars each preferred stock
in million

+ za PREFERRED STOCKS
 Ova znaci kje bide 9%
kje dobieme so istata formula
Ova znaci kje bide 2/15

15
2
the stock, current stock price
and net working capital
n equity and $238.47 million debt.

4
120
40
80
32
20

and net working capital

4
120
 40
80
32
48
88
20
68

alue at the horizon year)