In order to calculate Midland’s overall corporate WACC we must first determine the cost of equity and the cost of debt. The cost of equity can be defined as the risk-weighted projected return required by investors, where the return is largely unknown. Therefore the cost of equity for the upcoming year can be inferred by using the Beta of equity in the CAPM formula. In the case we are given the Beta of equity for the corporation. Therefore to calculate the cost of equity we plug the Beta of equity into the CAPM formula. Through this calculation we conclude that the cost of equity is 11.23%. These are the results we obtain:
Company's Beta of Equity = 1.25|
Find Cost of Equity (Ke) by CAPM|
Ke @ EMRP of 5% = .0498+1.25(.05)| 0.11230 |
The next step Midland needs to take in order to determine its corporate WACC, is to find the cost of debt. We can be more confident in the actual future cost of the debt in the future because it is a set amount of interest paid to debt holders. In the case we are told the Midland’s debt was rated A+ by the Standard and Poors. It also provides us with the current yields on US treasury bonds in Jan. 2007. Because of Midland’s upstanding credit rating, we concluded that they would be able have a cost of debt at 4.98%. The 4.98% comes from Table 2 in the case and is the 30 year maturity bond. We determined to use the 30 year bond because Midland is not solely focusing on growing only in the next year or two, but continuously in the future.
Once we have determined the cost of equity and the cost of debt for Midland the next step is to figure out the weight of debt and equity in the firm and plug our numbers into the WACC formula given below:
WACC = Ke(E/V)+Kd(D/V)
In exhibit 5...