In early 2003, Boeing released plans to build a new “super efficient” jet called the 7E7. The jet subsequently gained the nickname the “Dreamliner.” In the six months following the announcement news depressed the market for aircraft, which was already shrinking. This news included the United States going to war with Iraq, global terrorist attacks, and SARS putting travelers in fear. This all contributed to the worst airline profits in a generation. From Boeing’s perspective this meant for a promising market to introduce a major new product. Boeing moved forward with this concept and planned to release the 7E7 in 2008. It is Michael Bair’s job to make a recommendation to the board of directors for a final decision on the project. In order to do this he will need to complete a valuation of the 7E7 project in order to convince Boeing’s CEO and other upper management that the project would be financially profitable for Boeing’s shareholders.

In order to complete this financial analysis, Bair will need to calculate Boeing’s WACC along with IRR to determine whether this is a financially worthwhile project. In order to calculate the WACC, Bair must consider the betas from Boeing’s commercial sector as well as the defense sector. One beta cannot be used for the whole company due to the vast difference in volatility between the two sectors. Once these two separate betas are calculated, they can be weighted based on the % revenue which each industry contributes to the company and then a WACC can be calculated for Boeing as a whole. This number is then compared with the IRR of the 7E7 project to determine whether the project should continue. Based on the results of this analysis, I determined that Boeing should take on the 7E7 project. All calculations are provided below. Appendix #1

Why is Boeing contemplating the launch of the 7E7 project? Is this a good time to do so?
Boeing is contemplating launching the 7E7 for a few reasons. The first reason is...

...discounted payback NPV IRR, MIRR
The Cost of Capital
• Cost of Capital Components
– Debt – Common Equity
• WACC
Should we focus on historical (embedded) costs or new (marginal) costs?
The cost of capital is used primarily to make decisions which involve raising and investing new capital. So, we should focus on marginal costs.
What types of long-term capital do organizations use?
nLong-term debt nEquity
Weighted Average Cost of Capital is the weighted Average of the Marginal Costs of the Capital Components employed to acquire a long term asset (make a new real investment in things like Plant and Equipment, R&D, Human Capital, a new Product, a new Process, or a new Marketing Channel
Capital Components
Sources of funding that come from investors.
Accounts payable, accruals, and deferred taxes are not sources of funding that come from investors, so they are not included in the calculation of the cost of capital. We adjust for these items when calculating the cash flows of a project, but not when calculating the cost of capital.
WACC Estimates for Some Large U. S. Corporations
Company WACC Intel (INTC) 16.0 Dell Computer (DELL) 12.5 BellSouth (BLS) 10.3 Wal-Mart (WMT) 8.8 Walt Disney (DIS) 8.7 Coca-Cola (KO) 6.9 H.J. Heinz (HNZ) 6.5 Georgia-Pacific (GP) 5.9 wd 2.0% 9.1% 39.8% 33.3% 35.5% 33.8% 74.9% 69.9%
What factors influence a company’s WACC?
• Market conditions, especially interest...

...project evaluation thus it could provide the more pessimistic scenario. The larger the discount rate from the CAPM, the more inflation we assume in our projection.
Calculation of CAMP:
R = 4.56 +6.4*1.02=11.08%
The appropriate required rate of the return for evaluation the 7E7 project is 11.08%.
In EHHIBIT 10, it shows market-value debt/equity ratios, so it assumes that this ratio reflects the Boeing’s capital structure and using only debt and equity as finance the 7E7 commercial aircraft project in this case. There are two formulas to calculate the weight of debt and equity as show below:
Debt/Equity=0.525 (D/E=0.525)
Debt+Equity=1 (D+E=1); D=1-E
Using the second formula substituting back into the first equation and the result is 1-E/E=0.525, so through calculating this equation, it can indicate that E is 0.656 and D is 1-0.656=0.344. The Boeing’s capital structure is that the weight of debt is 34.4% and the weight of equity is 65.6%.
From this case, it gives a well-known formula how to finance Boeing’s weighted-average cost of capital (WACC), it shows below:
WACC= (percent Debt) (Pretax cost of debt capital) (1- Marginal effective corporate tax rate) + (percent Equity) (Cost of equity capital)
In previous calculation, it already know the percent Debt is 34.4%, percent Equity is 65.6%, Cost of equity capital is 11.088% and in this case gives Marginal effective corporate tax rate is...

...9 Calculating WACC
Mullineaux Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and a 35 percent debt. Its cost of equity is 12.5 percent, the cost of preferred stock is 5.5 percent, and the cost of debt is 7.2 percent. The relevant tax rate is 35 percent.
a. What is Mullineaux’s WACC?
b. The company president has approached you about Mullineax’s capital structure. He wants to know why the company doesn’t use more preferred stock financing, since its cost less than debt. What would you tell the president?
Weighted average Cost of Capital = E/V * Cost of Equity + D/V * cost of debt * (1-tax rate)
Answer A - Mullineaux's WACCWACC = 60%*14 + 5%*6 + 35%*8*(1-0.35)
WACC = 8.4% + 0.3% + 1.82%
WACC = 10.52%
Answer B
Lets analyse to following situations..
Situation 1 - Equity 50%, Preferred Stock 25% & Debt 25%
WACC = 50%*14 + 25%*6 + 25%*8*(1-0.35)
WACC = 7% + 1.5% + 1.3%
WACC = 9.8%
Situation 2 - Equity 60%, Preferred Stock 20% & Debt 20%
WACC = 60%*14 + 20%*6 + 20%*8*(1-0.35)
WACC = 8.4% + 1.2% + 1.04%
WACC = 10.24%
Situation 3 - Equity 60%, Preferred Stock 35% & Debt 5%
WACC = 60%*14 + 35%*6 + 5%*8*(1-0.35)
WACC = 8.4% + 2.1% + 0.26%...

...1. Why do think Larry Stone wants to estimate the firm’s hurdle rate? Is it justifiable to use the firm’s weighted average cost of capital as the divisional cost of capital? Please explain.
(10% weighting)
Answer
The hurdle rate is the rate of return a firm has to offer finance providers to induce them to buy and hold financial security. (Arnold,2007). This is also known as cost of capital or weighted average cost of capital. The returns offered by alternative securities with the same risk influences the hurdle rate.
Larry Stone would need to estimate the firm’s hurdle rate because the firm would have to earn a minimum rate of return to cover all the costs generated from funds used to finance investment. The firm’s bonds and stocks would not be sold if the firm does not a minimum rate that covers their cost of generating funds.
When there are differences in the degree of risk between the firm and its divisions then it is not justifiable to use the firm’s weighted average cost of capital as the divisional cost of capital.
We use the company's cost of capital to value new assets which have the same risk as the old ones. If the company is acquiring new assets whose risk is more or less than the risk of the existing assets then the capital required to finance(fund) the new assets will have a different cost of capital as investors demand a return based on the risk to their investment....

...providing by creditors and shareholders. Managers use cost of capital as the discount rate in net present value (NPV) project appraisal techniques.1
The weighted-average cost of capital (WACC) represents the overall cost of capital for a company, including the costs of equity and cost of debt, weighted according to the proportion of each source of finance within the business. In easy words WACC measures a company’s cost to borrow money.
The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:
Where:
Re = cost of equity ; Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate
The higher the WACC, the less possible it is that the company is creating value, because it has to overcome more expensive borrowing cost in order to make a profit.
In practice, WACC is often used internally by managers, as a part of determining, whether it would be profitable for the company to finance a new project. For external investors, as one way to value the company’s shares, and decide, is it worth to invest or not.
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1 Ian Cornelius, WACC attack, CIMA Insider, March 2002, p.22...

...CAPITAL (Et al) EXERCISES
1. Consider the following data regarding the cost of capital of an italian auto manufacturing firm:
* Capital structure includes 40% debt
* Industry average unlevered beta is 1.8
* 10 year Italian Government bond yield is at 4.5%
* JP Morgan has issued an estimate for Expected Market Return at 8.5%
* Euribor is 2%
* Before tax cost of debt = 5%
* Tax rate = 30%
Please calculate the weighted average cost of capital (WACC) for this firm.
2. You are now asked to calculate the WACC for a toothpaste manufacturer with the following data:
* Average share price for last 6 months = €34/ share
* Current year’s dividend = €3/ share
* Applicable growth rate = 3%
* Tax rate = 35%
* Company is financed via 75% equity
* Industry average unlevered beta = 1.84
* Company’s debt is in the form of a syndicated loan that carries an interest rate of 4.5%
Please calculate the weighted average cost of capital (WACC) for this firm.
3. As an IE Business School graduate, you become the new CFO in the family owned firm. The company is struggling with liquidity, so you know you will need to use your best skills to get debt rolled over. Your elders (the Board) ask you to calculate the cost of equity with the following information:
a. Historically, shareholders have perceived a return of 4% over that of debt holders, to...

...Case Study II : Weighted Average Cost of Capital
Introduction and objectives
This paper aims at describing a way to compute the Weighted Average Cost of Capital (WACC). This method is often used by company management to determine the economic feasibility of different projects and thus to compute the NPV of a specific project by discounting cash-flows. The WACC determines the return that the company should generate to satisfy its debt-holders. For the company, it consists in a tool for projects decision-making, whereas for the creditors, it is in an indicator of what they can expect to receive as return from their investments and a measure of the global risk associated to the company. Our choice fell on Hewlett-Packard (HPQ), whose activities are computer hardwares and is part of the S&P500.
Assumptions
Cost of equity:
Cost of equity is computed by using the CAPM formula (1). This equation links the risk premium on the market (S&P500) to the excess return of the stock (HPQ) by a factor Beta (B). B is the covariance between the market and stock return divided by the variance of the market.
ErE=rf+β∙E[risk premium] (1)
1. Risk-free rate : The first thing to be found is the risk-free rate. The WACC evaluation should be made through eyes of the company’s most probable investors, which we assumed to be American as HPQ is listed on the US market. The best proxy for rf is therefore the US...

...What is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not?
1.1 The definition of WACC Weighted average cost of capital(WACC), is a weighted-computational method of analyzing the cost of capital based on the whole capital structure of a firm. The result of WACC is the rate a firm use to monitor the application of the current assets because it represents the return the firm MUST get. For example this rate could be used as the discount rate of evaluating an investment, and maintaining the price of firm’s stock.
1.2 Analysis of Johanna Cohen’s calculation We analyzed the process of Johanna Cohen’s calculation, and found some flaws we believe caused computational mistakes.
i. When using the WACC method, the book value of bond is available as the market value since bonds are not quite active in the market, but the book value of equity isn’t. Instead of Johanna’s using equity’s book value, we should multiply the current price of Nike’s stock price by the numbers of shares outstanding.
ii. When calculating the YTM of the firm’s bond, Johanna only used the interest expense of the year divided by the average debt balance, which fully ignored the discounted cash flow of the cost of debt.
2. If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared...