the WACC for the firm will be different at different blends of debt and equity financing (which means the value of the firm will be different at different blends of debt and equity financing) You can see the effect in the WACC formula: WACC = Wd(ATRd) + Ws(Rs) (no preferred stock in this example) If AT Rd = 6% and Rs = 12%: At zero debt: WACC = 0(.06) + 1.00(.12) = .12, or 12% At 50/50 debt and equity WACC = .50(
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Capital Structure – Chapt. 16 in text Does Capital Structure affect firm value? MM Proposition I (No Taxes): The value of a levered firm is equal to the value of an unlevered firm. VL = VU. i.e., Financing Choices do not add value. Why? Because you can create homemade leverage if you wish. • Unlevered Firm vs. a Levered Firm with the same assets. Recapitalization of Trans Am Corporation. Debt issue of $4,000,000 at 10% to buy back equity. Alternatively, you may view them as
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Bond yield and cost of debt 9 Table 2: Sinking fund cash flow 11 Table 3: Own-bond-yiel-plus-risk-premium 12 Table 4: Cost of Equity, CAPM 14 Table 5: Cost of Equity, DCF 15 Table 6: Issuance of new common stock 18 Table 7: PNC’s WACC 18 Table 8: Capital budget 19 Table 9: Project evaluation 20 Table 10: Capital structure (weights) 21 Table 11: Capital structure (costs) 21 Table 12: Euro-denominated bonds 22 Executive Summary
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Haverford Company sold a $1,000 par value bond that now has 25 years to maturity and an 8.00% annual coupon that is paid quarterly. The bond currently sells for $900.90, and the company's tax rate is 40%. What is the component cost of debt for use in the WACC calculation? A. 5.40% B. 5.73% C. 5.98% D. 6.09% E. 6.24% 2) Assume that Mary Brown Inc. hired you as a consultant to help it estimate the cost of capital. You have been provided with the following data: D0 $1.20; P0 $40.00; and g 7%
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capital?” Survey Findings The detailed survey results appear in Exhibit 2. The estimation approaches are broadly similar across the three samples in several dimensions. • Discounted Cash Flow (DCF) is the dominant investment-evaluation technique. • WACC is the dominant discount rate used in DCF analyses. • Weights are based on market not book value mixes of debt and equity.8 • The after-tax cost of debt is predominantly based on marginal pretax costs, and marginal or statutory tax rates. • The
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Wal-Mart and Target WACC We computed the WACC for Wal-Mart and Target based on their most current financials. The weights of debt and equity were obtained from MorningStar.com. The risk free rate is the current rate for 30 year treasuries, and the cost of debt is the current 20 year rate on corporate bonds rated AA and A+. The tax rates were estimated by dividing the taxes paid from the operating income from Wal-Mart and Targets income statements. The market risk premium was obtained from the
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of business, but they rebounded and remain profitable. This example shows that a company can make a bad decision and continue to be profitable in the long run. But, repeat bad investment decisions and a company will go broke. Question #5 How does WACC change over time? What do you think might drive the changes? WACC is the opportunity cost of investing in a company, or the expected return of shareholders and debt holders. WACC consists of all capital sources and includes common stock, preferred
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the WACC for the firm will be different at different blends of debt and equity financing (which means the value of the firm will be different at different blends of debt and equity financing) You can see the effect in the WACC formula: WACC = Wd(ATRd) + Ws(Rs) (no preferred stock in this example) If AT Rd = 6% and Rs = 12%: At zero debt: WACC = 0(.06) + 1.00(.12) = .12, or 12% At 50/50 debt and equity WACC = .50(
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The pound-based WACC for Grand Met is 12.81%, while its dollar-based WACC is 11.01% 1.748 (1.027/1.043) = 1.721185 Spot rate, expected exchange rate. This shows that the dollar is appreciating in relation to the pound. This is expected as inflation is expected to be higher in the UK. This also explains the differences in the WACC between the two countries. In order to preclude arbitrage opportunities and account for difference in inflation rates, pound-based WACC has to be higher than the
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------------------------------------------------- FI – 516 – WEEK 2 - MINI CASE – ANSWER KEY Assume that you have just been hired as a business manager of PizzaPalace, a regional pizza restaurant chain. The company’s EBIT was $50 million last year and is not expected to grow. The firm is currently financed completely with equity, and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms’ owners would
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