The cost of company’s capital can be define of as the minimum return required by providers of finance for investing in an asset, whether that is a project, a business unit or an entire company. It is important to reflect the capital structure used to finance the investment. To create a capital companies usually use a funds 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...

...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...

...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...

...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....

...The Cost of Capital Project: Internet Version {December 2009}
By
Wm R McDaniel, PhD
Objective
The assignment is to estimate the weighted average cost of capital (WACC) for an actual corporation as of the current time. Actual managers would need to know their company’s WACC as a starting datum to estimate the discount rate to use in the net present value analysis of new projects or of termination decisions. The student will later need to know the technique for application in some case study solutions.
The project also develops student skills in using elementary financial management models, in dealing with situations where there are too much or too little data, in employing publicly available data sources, and in working around naturally occurring measurement errors.
The Primary Equations
The theory of why managers should use WACC in net present value analysis comes later in the course. For now, start with the equations for WACC, per se:
ka = ke(E/V) + kd(1 – t)(B/V) + kp(P/V) + kL(L/V) [1]
V = E + B + P + L [2]
The symbol, ka, is the same as WACC. V is the total market value of the corporation. The identities of all other symbols are in the paragraphs below. Note from the beginning that all variables are estimates of...

...Chapter 12 – Determinants of Beta and WACC
[pic]
Ct is not known for certain. It is a random variable. It has a probability distribution with a mean and standard deviation.
Ct = E(Ct) = expected cash flow
“r” is the appropriate cost of capital. It should have the same riskiness as Ct
If Ct is a normal extension of the firm’s operations, and the firm is entirely equity financed, we use the stockholders’ required return as found through the CAPM for the appropriate value of ‘r’.
E(Ri) = Rf + (i (Rm – Rf)
Remember: the Beta of security i is the standardized covariance of its returns with the returns on the market portfolio.
(i = Covi,Mkt
(2Mkt
Determinants of Beta
1. Cyclicality of revenues – How responsive are revenues to changes in the business cycle?
Does the firm produce normal goods or inferior goods?
Highly cyclical ( high covariance with the market ( high beta.
2. Operating Leverage (Degree of Operating Leverage) – Degree to which costs are fixed.
High FC relative to VC ( high operating leverage
Contribution margin = Price – VC = incremental profit from an additional sale
Low Contribution margin = low FC & high VC = low DOL – example is grocery store
High Contribution margin = high FC & low VC = high DOL – example is airline
High Operating Leverage ( profits are more responsive to changes in sales ( higher beta
3. Financial Leverage – similar to operating leverage if we think of debt as a FC...

...chlorate producers (i.e. Brunswick Chemical and Southern Chemicals who specialize in producing sodium chlorate) are obtained to estimate the appropriate unlevered beta for Collinsville at 1.09. As a result, Collinsville’s estimated relevered beta is 1.39.
Re = 9.5% + (1.39 * 7.25%) = 19.57%
Tax Rate:
From the perspective of Dixon Corporation, the cost of capital evaluation would start out in estimating the appropriate tax rate for the Collinsville investment. The most recent year’s (1979) nominal tax rate of 48.69% for Dixon is assumed for Collinsville since company’s profits are taxed as a whole.
Tc = 3818 / (3818 + 4024) = 48.69%
Cost of Capital (WACC):
WACC = (65% * 19.57%) + (35% * 11.25% * (1 - 48.69%))
WACC = 14.74%
With the target leverage ratio at 35% and the tax shield at 49%, the resulting WACC for Collinsville is 14.74%....

...Executive Summary:
The purpose of this paper is to identify the weighted average cost of capital (WACC) in relation with the firm value. Also, there are some aspects discussed in the paper regarding when a firm should accept a project and when to reject. Systematic risk will be also discussed in the paper concerning their target market and how risky is that. Finally, the approach that BlackBerry took into consideration to overcome their risk.
Discussion:
All companies’ assets are financed by either equity or debt. The equity is the amount of fund that contributed by the shareholders. The debt is the amount of money that the company borrowed from banks. WACC is the average cost of growing the capital in the company. For example, if the company’s return is 16% and the WACC is 10%, then, the company makes 60 cents for each dollar invested into the capital. The weighted average cost of capital is a determination of how much the company should put for their investors and lenders. WACC is an important tool that used by both the investors to know how much their required rate of return is and by the firm to establish a target. The weighted average cost of capital is related to some other important tools such as the systematic risk, unsystematic risk and corporate valuation.
First is the corporate valuation. The corporate valuation is “Present value of expected future cash flows discounted at the weighted average cost of...