THE WEIGHTED AVERAGE COST OF CAPITAL

The weighted average cost of capital (WACC) is calculated using the firm's target capital structure
together with its after-tax cost of debt, cost of preferred stock, and cost of common equity.

PROBLEM
A firm's target capital structure consists of 30 percent debt, 10 percent preferred stock, and 60
percent common equity. Using the relevant costs calculated previously, what is the firm's
weighted average cost of capital?
W*K
wd = 30% rd = 6.6 1.98
wp = 10% rp = 10.25641 1.025641
ws = 60% rs = 14.58667 8.752
11.75764
WACC Problems

Suppose a company uses only debt and internal equity to Finance its capital budget and uses CAPM to compute its cost of eq
debt and 25% internal equity. Before tax cost of debt is 12.5 % and tax rate is 20%. Cost f equity is 18%. Ca

A company with a tax rate of 30% has the following capital s

Weight Instrument Pre-tax cost of capital
40% Bonds 6%
50% Ordinary shares 12%
10% Preference shares 8%
What is the company’s weighted average cost of capital?

tax rate 30%

pre tax %age post tax %age wacc
weight of debt 40% cost of d 6% cost of d 4% 1.68%
weight of equity 50% costof e 12% cost of e 12% 6.00%
weight of pre share 10% cost ofp 8% cost of p 8% 0.80%
total 8.48%
APM to compute its cost of equity. The capital structure is 75%
s 20%. Cost f equity is 18%. Calculate WACC.

owing capital structure:

t of capital

of capital?
 EARNINGSSS MULTIPLIER APPROACH

EPS 1.4
Dividend 0.49 EPS1 ( 1  b ) eps earning per share
ROE 15% ke   br (g  br)b retention rate
P0
Require
Return 12% EPS r roe
DPR 0.35  1 (b  0) Ke rrr
b 0.65 P0 Po current market price
groth(br) 9.75% growth B*R
stock
Value 21.777777778 eps*(1-b)/(Ke-growth)

Calculate the growth rate and stock value as the ROE changes
earning per share
retention rate

current market price

Given the long-run gFCF = 6%, and firm discount rate of 10%, use the cah flow model to find the firm’s
value, if FCF for year 1, 2 and 3 are -5, 10 and 20 respectively. If the firm has $40 million in debt and has 10
million shares of stock, what is the firm’s stock value per share?

FCF1 FCF2 FCF3 P3

solution yrs 1 2 3 3
constant g 6% FCF -5 10 20 530 p3= FCF4/(ke-g)
pvfcf ₹ -4.55 ₹ 8.26 ₹ 15.03 ₹ 398.20 FCF4= FCF3+(FCF3*g)
dis rate 10%
Debt 40 total value ₹ 416.94 fcf 1 fcf 2 fcf 3
o/s shares 10 debt 40 yrs 1 2 3
equ value ₹ 376.94 fcf -5 -10 20
o/s share 10 ₹ -4.46 ₹ -7.97 ₹ 14.24
eq value pe ₹ 37.69 8%
12%
p3= FCF4/(ke-g)
FCF4= FCF3+(FCF3*g)

p3
3
540
₹ 384.36

₹ 386.16
 BALANCE SHEET of A ltd. AS ON 31.03.2019

Liabilities Value Assets Value

Net Fixed
Shareholder Funds 250 Assets 400

Net
Equity Capital ( 10 crore shares 100 Working 100
of Rs 10 each)
Capital
Reserves and Surplus 150
Loan Funds Rate 250
Total 500 Total 500

WACC tax
pre tax
Wd 0.5 Cost of d 9%
We 0.5 Cost of e 16%

Nopat/invested capital= 12%

inv capital= 500

CASH FLOW
20% 20% 20%
years 1 2 3 4
NOPAT 60 72 86.4 103.68
Assests 500 600 720 864
inv(capex) 100 120 144 103.68

cash flows -40 -48 -57.6 0.00

PV CF ₹ -36.04 ₹ -38.96 ₹ -42.12 ₹ 0.00

Total pv cf ₹ 748.14
Debt 250
total euity ₹ 498.14
equity capital(10 cr 0f rs 10 each)
equity value (intrensic value) ₹ 49.81
 The return on invested capital (NOPAT/Invested Capital) of A
ltd. is expected to be12 %. The Effective tax rate is 33.33%.
Debt/Equity=1:1, Kd=9% Ke=16%.The growth rate in assets,
Revenue and NOPAT will be 20% for first 3 years, 12% for next 3
years and 8% thereafter. Calculate the intrinsic value of Equity
Share.

33.33%
post tax %age WAAC
cost of d 6.0% 3%
cost of e 16% 8%
WAAC 11% 0r 11%

12% 12% 12% 8%

5 6 7 7 9
116.12 130.06 145.66 157.3159698432
967.68 1083.802 1213.858 1310.96641536
116.1216 130.0562 97.10862 -1310.96641536
(D7+(D7*G))/(Ke-g)
0.00 0.00 48.55 1747.87
₹ 0.00 ₹ 0.00 ₹ 23.39 ₹ 841.87