...WEIGHTED AVERAGE COST OF CAPITAL (WAAC) 4/28/2015 Table of Contents TASK REQUIREMENT 25% 3 WEIGHTED AVERAGE COST OF CAPITAL (WACC) 3 WACC Formula: E /V * Re + D/V *Rd * (1-Tc) 3 DEMONSTRATION OF APPLICATION KNOWLEDGE 55% 5 Describe capital structure 5 Indicate how these might be useful to determine the feasibility of the capital project 5 Recommend which is more appropriate to apply to project evaluation. 5 Define marginal cost of capital 5 ACADEMIC WRITING 20% 7 References 7 Footnotes 8 Tables 9 Figures 10 TASK REQUIREMENT 25% WEIGHTED AVERAGE COST OF CAPITAL (WACC) WACC Formula: E /V * Re + D/V *Rd * (1-Tc) The acronyms in the formula are• Re = Cost of equity or CAPM • Rd = Cost of debt • E = Market value of the firm's equity (market cap) • D = Market value of the firm's debt • E/V = Percentage of financing that is equity • D/V = Percentage of financing that is debt • Tc = Corporate tax rate The following assumptions are received from Mary Frances (CFO) of Apex to be used in the WACC calculation: * Weights of 40% debt and 60% common equity (no preferred equity) * A 35% tax rate * Cost of debt is 8% * Beta of the company is 1.5 * Risk-free rate is 2% * Return on the market is 11% Using Ms. Frances data below you will see the calculations in determining the WACC. Below in table 1 the calculations for inputs and outputs and have been tabulated based on below formula for the WACC. Cost of equity is 18.50% and...
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...Chemical’s weighted average cost of capital (WACC). Note: round to the nearest whole number. Discuss the theory used by Clarkson to determine Cape Chemical’s optimum target capital structure (30% debt and 70% equity). Cape Chemical’s weighted average cost of capital (WACC) is 15%. Cape Chemical’s optimum target capital structure theory, used by Clarkson, is considered a systematic approach to funding business activities. Furthermore, the traditional capital structure theory aims to minimize WACC, while also maximizing the firm’s value. As a result, Clarkson chose the capital structure which would yield a lower WACC for Cape Chemical. This produced a lower cost of debt capital and a higher cost of equity capital. Moreover, the cost of debt is lower because it holds less risk since debt payments are more definitive than equity payments. With debt payments, Cape Chemical would only have to worry about principal and interest payments, whereas, the dividends and stock appreciation that comes with equity payments are less definitive and have more risk (Ross, 2015). Overall, capital budgeting is useful because it...
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...Corp. senior management with an evaluation of the company’s weighted average cost of capital (WACC). Since the 2010 financial information is not yet to be finalized, the analysis will use the most currently published financial data to evaluate each component of the WACC, including the company financial structure, cost of debt, and cost of equity. I. Target Corp. Financial Structure According to the consolidated balance sheet on January 30, 2010 (exhibit 1), the total amount of debt, including short-term and long-term debts and other current liabilities was at $16.814 billion. Account Payable is excluded from the WACC’s debt component because it is not a source of funding that comes from investors. Also in January 30, 2010, Target‘s market capitalization was at $36.176 billion (708.08 million shares at $51.09/share). As a result, the company was financed with 31.7% debt and 68.3% equity. II. Cost of Debt A close estimate for the cost of debt would be the yield to maturity of Target’s corporate bonds because it reflects the expected return of debt holders from investing in this type of corporate security. Exhibit 4 lists several Target corporate bonds with similar term length and slightly different time of issuance. For this analysis, I used the average yield to maturity of 5.06% as an appropriate estimate of the borrowing rate. III. Cost of Equity The analysis used the CAPM model to determine the cost of equity. * Risk-free rate: For the purpose of this analysis...
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...1. Does Pioneer calculate its cost of capital correctly? 2. How should Pioneer’s cost of equity capital be estimated? 3. What is Pioneer’s weighted average cost of capital? 4. Should Pioneer use a single cost of capital or multiple or divisional hurdle rates in evaluating projects and allocating investment funds among divisions? If multiple rates are used, how should they be determined? 5. Should the discount rate for environmental projects vary by division or be the same throughout Pioneer?1. Does Pioneer calculate its cost of capital correctly? 2. How should Pioneer’s cost of equity capital be estimated? 3. What is Pioneer’s weighted average cost of capital? 4. Should Pioneer use a single cost of capital or multiple or divisional hurdle rates in evaluating projects and allocating investment funds among divisions? If multiple rates are used, how should they be determined? 5. Should the discount rate for environmental projects vary by division or be the same throughout Pioneer?1. Does Pioneer calculate its cost of capital correctly? 2. How should Pioneer’s cost of equity capital be estimated? 3. What is Pioneer’s weighted average cost of capital? 4. Should Pioneer use a single cost of capital or multiple or divisional hurdle rates in evaluating projects and allocating investment funds among divisions? If multiple rates are used, how should they be determined? 5. Should the discount rate for environmental projects vary by division or be the same throughout Pioneer?1...
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...2016. Deliverable The Weighted Average Cost of Capital I choose Costco Corporation, which is an American based company that sells a variety of merchandise. The company is also a wholesale company and it supplies its products and services to various countries despite the United States of America. The company is traded on NASDAQ with ticker symbol COST. As at 2015, the company had revenue worth US $ 116.553 billion, operating income worth US $ 3.62 billion, total assets worth US $ 33.44 billion, total equity worth US $ 10.61 billion, and 117,000 employees. According to yahoo finance, Costco Corporation had short-term debt of $ 1,283,000, long-term debt of $ 4,864,000 giving a total debt of $ 6,147,000, and shareholder’s equity worth $ 10,617,000 as at 2015. It is also evident that the company had an interest expense of $ 124,000 as at that year. The market capitalization of the selected company is $ 65.32 billion with a beta of 0.84. In this report, I will consider a risk premium of 4 percent and a risk-free rate of 1.83 percent. Weighted Average Cost of Capital is the calculation of an organization’s cost of capital in relation to its weight. These sources of capital include preference shares, common stock, and debt whether short term or long term. It is used as a discounting rate to calculate the profitability of a project using a technique like Net Present Value approach. To calculate the Weighted Average Cost of Capital, we use the formula below: ...
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...furniture at premium prices. New competition has caused Guillermo to rethink its strategy. The store must analyze the most advantageous way to stay competitive in their current market. Their choices are to stay the current course, become hi-tech, or a brokerage company. Guillermo Furniture Analysis Guillermo Furniture store was dominant in its region in developing customize furniture. However, they are starting to lose money because of competition from overseas and rising labor cost. The company must make a decision on how to proceed in the future. To ease their decision process they can use the following: five steps as a project moves from idea to reality: 1. Generating ideas for capital budgeting projects 2. Reviewing existing projects and facilities 3. Preparing proposals 4. Evaluating proposed projects and creating the capital budget, the firm has set of planned Capital expenditures 5. Preparing appropriation requests (Douglas R. Emery, 2007) In generating ideas for capital budgeting projects Guillermo has come up with three possible choice. They can stay with their current activities, become hi-tech, or be a brokerage firm for a company in Norway. Reviewing existing projects and facilities: new competitor from overseas entered the furniture market. Using a high-tech approach; One of the largest retailers in the nation’s headquarters was just a few miles down the road, and its influence had expanded considerably; consolidating into larger organizations by...
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...Executive summary In this report we focus on Nike's Inc. Cost of Capital and its financialimportance for the company and future investors. The management of NikeInc. addresses issues both on top-line growth and operating performance. The company's cost of capital is a critical element in such decisions and it isimportant to estimate precisely the weighted average cost of capital (WACC). In our analysis, we examine why WACC is important in decision making andwe show how WACC for Nike Inc. is calculated correctly. Also, we calculatethe company's cost of equity using three different models: the Capital AssetPricing Model (CAPM), the Dividend Discount Model (DDM) and the EarningsCapitalization Model (EPS/ Price), we analyze their advantages anddisadvantages and finally we conclude whether or not an investment in Nikeis recommended. Our analysis suggests that Nike Inc.'s common stock should be added to theNorth Point Group's Mutual Fund Portfolio. I. The Weighted Average Cost of Capital and its Importance for Nike Inc. The Weighted Average Cost of Capital (WACC) is the average of the costs of a company's sources of financing-debt and equity, each of which is weightedby its respective use in the given situation. By taking a weighted average,we can see how much interest the company has to pay for every marginaldollar it finances. A firm's WACC is the overall required return on the firm asa whole and, as such, it is often used internally by company directors todetermine the economic...
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...Identify the components of a stock’s realized return. “The realized return is the total realized return that happens during a specific period (Jonathan Berk, 2010, p. 388).” The components consist of the stock price that it was bought, the price it was sold, and also the dividend. To calculate the stock’s realized return begin by dividing the dividend by amount that it was bought and adding it to the difference between the amount that it was sold by the amount that it was bought and finally dividing that by the amount that it was bought (Jonathan Berk, 2010, pp. 338-341). This will be the last component to a realized return. Contrast systematic and unsystematic risk. “Unsystematic risk is fluctuations of a stock’s return that are due to company or industry specific news” (Jonathan Berk, 2010, p. 353). This is associated with random causes that can be eliminated through diversification. It’s attributed to firm-specific events such as strikes, lawsuit, regulatory actions, or a loss of a key account. Unsystematic risk is due to factors specific to an industry like labor unions, product category, research and development, pricing, or marketing On the other hand, systematic risk occurs when fluctuations of the stocks returns are changed because of market wide news (Jonathan Berk, 2010, p. 353). These market factors may include situations such as war, inflation, international incidents, or political events. It may be eliminated through diversification and the combination of...
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...down various expenses that were occurring. The stock market was responding to various signals to the changes Nike was making therefore, Ford did a cash flow estimation while she asked for help. Ford asked her new assistant, Joanna Cohen to estimate Nike’s cost of capital because her forecast seemed to be incorrect. Ford’s forecast showed that Nike had a discount rate of 12% and was undervalued at it current share price of $42.09. On the other hand, Ford conducted a quick sensitivity analysis that revealed Nike was undervalued at discount rates below 11.17%. What is the weighted average cost of capital (WACC)? The weighted average cost of capital otherwise known as the “WACC” is the capital finding of a company, that which has been developed in two aspects, debt and equity. Lenders as well as equity holders expect to have a certain return on the funds/capital they have provided. The cost of capital is then the expected return to equity owners/shareholders and to debt holders. Therefore, the weighted average cost of capital can tell us that the return that both stakeholders and equity owners/lenders can expect to receive. Nonetheless, the weighted average cost of capital is a representation of the investor’s opportunity cost of taking on the risk and investing their...
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...Case Study: Marriott Corporation The Cost of Capital Teresa Cortez Keith Gemmell Brandon Papsidero Robin Reschke October 28, 2013 Table of Contents 1. Are the four components of Marriott’s financial strategy consistent with its growth objective? ...................................................................................................................... 1 2. How does Marriott use its estimate of its cost of capital? Does this make sense? ...... 3 3. What is the weighted average cost of capital for Marriott Corporation? ..................... 4 4. What type of investments would you value using Marriott’s WACC? ........................ 6 5. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time? ......... 7 6. What is the cost of capital for the lodging and restaurant divisions of Marriott? ........ 8 7. What is the cost of capital for Marriott’s contract services division? How can you estimate its equity costs without publicly traded comparable companies? ................ 11 APPENDIX I – Math Utilized to Derive WACC for Marriott .......................................... 13...
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...“Calculate and make a recommendation on how Telus should employ their cost of capital." Introduction: In introducing this case the basic problem do be solved deals with determining the cost of capital within the organization of Telus. Barb Williams and Rick Thomas both managers from service firms, were attending a business seminar when given an assignment to calculate the cost of capital for Telus. They were given basic data including balance sheets, income statement, data on Telus common stock, market index, and average annual returns in North America capital markets. This information was given to them in order to calculate the cost of capital within the company and to make a recommendation on how to employ their cost of Capital. In order to determine the actual cost of capital, various steps need to be taken in finding out cost of debt, equity, preferred shares in order to determine the overall weighted average cost of capital (WACC) within the company. What is WACC? Weighted average cost of Capital is defined as a calculation of a firm’s cost of capital in which each category of capital is properly weighted. All capital resources are used in determining this cost which includes common stock, preferred stock, bonds and any other long term debt. Calculating overall WACC. Use of short and Long term debt When calculating the cost of debt for this case, it is necessary to take into account both the long and short term components of Telus’ financing via debt...
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...Midland Energy Resource Report for Cost of Capital October 16, 2014 Abstraction General Analysis of Midland Energy Resources Cost of Debt • • • • Consolidated Company Exploration & Production Refining and Marketing Petrochemicals Cost of Equity Equity market risk premium of 5% is reasonable. According to the Exhibit 6, the U.S. stock return minus Treasury bond yields for each period varies. Since each period has different standard error, it will be better to take the weighted average of the data, then EMRP is approximately 5.9% or lets say 6.0%. Comparing to the EMRP that Midland would use in the calculation of WACC which is 5%, the historical data reflects a higher EMRP. But from the market risk premium survey results, we see that finance professors, CFOs and fund managers advocate a lower rate on risk premium. Because these people have better understanding in the performance of the market and be more aware of how economics works, then the analysis from them should be taken into great consideration. Therefore, 6.0% from the past data balanced with some lower rates that suggested by bankers, auditors as well as Wall Street analysts, 5% should be appropriate. Weighted Average Cost of Capital WACC = λ(1 − t)KD + (1 − λ)KE The Effect of Leverage on the Cost of Equity and WACC Cost of Equity The relation between cost of equity and leverage can be shown as follows: βEquity = 1 βU (1 − λ) Asset Cost of Equity = Risk Free Rate + βEquity × (Risk Premium) We further illustrate...
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...devilment. From 1924 to the present, pioneer has been able to expand both vertically and diversify horizontally. With such resources and capital, the company has to oversee so many opportunities and ventures. Presently the company is at odds over whether they should use a company wide cut off rate based on the overall weighted average cost of capital or if Pioneer should use multiple rates that reflect risk-profit characteristics of the several businesses or economic sectors. At first we must decide if the methodology used in computing the company’s overall weighted average cost of capital is just. Second, we should decide in which terms Pioneer adheres to future investments. Should they adjust discount rates for different divisions and projects and stay away from a universal cutoff rate? Third, the capital budgeting criteria must be set for different projects across Pioneer’s divisions. What distinctions among projects need to be noted and how the standards should be determined are all questions that arise from judging how to proceed forward. Estimated overall corporate weighted average cost of capital: We assume all the basic data are correct. Given is the future Debt/Equity ratio (Estimated Proportions of future Funds Sources). Also Pioneer’s cost of equity was given as 10% (Rs). The company’s after tax cost of debt was 7.9% (Rb*(1-Tc). Tax rate was 34%. From the...
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...Decisions COST-VOLUME-PROFIT ANALYSIS 2.2 Cost Of Capital This Section includes : • Cost of Capital-Key Concepts • Importance • Classification • Determination of Cost of Capital • Computation • Weighted Average Cost of Capital INTRODUCTION: It has been discussed in lesson -4 that for evaluating capital investment proposals according to the sophisticated techniques like Net Present Value and Internal Rate of Return, the criterion used to accept or reject a proposal is the cost of capital. The cost of capital plays a significant role in capital budgeting decisions. In the present lesson the concept of cost of capital and the methods for its computation are explained. COST OF CAPITAL-KEY CONCEPTS: The term cost of capital refers to the minimum rate of return a firm must earn on its investments. This is in consonance with the firm’s overall object of wealth maximization. Cost of capital is a complex, controversial but significant concept in financial management. The following definitions give clarity management. Hamption J.: The cost of capital may be defined as “the rate of return the firm requires from investment in order to increase the value of the firm in the market place”. James C. Van Horne: The cost of capital is “a cut-off rate for the allocation of capital to investments of projects. It is the rate of return on a project that will leave unchanged the market price of the stock”. Soloman Ezra:”Cost of Capital is the minimum...
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...12 12A-1 Economic Value Added and the Measurement of Financial Performance Chapter 12 shows how to calculate the appropriate discount rate for capital budgeting and other valuation problems. We now consider the measurement of fi nancial performance. We introduce the concept of economic value added, which uses the same discount rate developed for capital budgeting. We begin with a simple example. Many years ago, Henry Bodenheimer started Bodie’s Blimps, one of the largest highspeed blimp manufacturers. Because growth was so rapid, Henry put most of his effort into capital budgeting. His approach to capital budgeting paralleled that of Chapter 12. He forecast cash flows for various projects and discounted them at the cost of capital appropriate to the beta of the blimp business. However, these projects have grown rapidly, in some cases becoming whole divisions. He now needs to evaluate the performance of these divisions to reward his division managers. How does he perform the appropriate analysis? Henry is aware that capital budgeting and performance measurement are essentially mirror images of each other. Capital budgeting is forward-looking because we must estimate future cash flows to value a project. By contrast, performance measurement is backward-looking. As Henry stated to a group of his executives, “Capital budgeting is like looking through the windshield while driving a car. You need to know what lies farther down the road to calculate a net present value...
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