Question Please help thanks For Kellog Rating Fitch: BBB Price 103.12 Coupon(%)

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Please help thanks

For Kellog

Rating Fitch: BBB

Price 103.12

Coupon(%) 3.125

Maturity 17-May-2022

YTM(%) 2.661

Current yield(%) 3.030

Cost of Debt

-Use the yield to maturity from either your company’s actual bond or from the similarly rated company’s bond as an estimate for your company’s pre-tax cost of debt.

-Calculate your company’s after-tax cost of debt using a 35% marginal tax rate. (Pre-tax cost of debt)(1 – marginal tax rate). Note bond rating for each company.

Cost of Equity

-Estimate the cost of equity at least two ways:

CAPM (You must use CAPM as one of your methods.)

Reworked Gordon Model: (D1/P) + G

Bond yield + risk premium

-Remember to use the current RFR (10 year Treasury Bond). Assume Required Return on the Market is 11%. Get current stock price. Get estimated D1 and G from either Valueline or Yahoo Finance (analyst estimates).

-Decide on your best estimate of cost of equity to use in calculating WACC.

Calculate the Weights of each Component of the Company’s Capital Structure

-Look at the company’s balance sheet and assume their current capital structure is their target capital structure.

-Use only Long Term Debt and any Capitalized Leases in the weighting for debt.

-See if the company has any preferred stock to weight.

-Use total common shareholder’s equity for the weight of common equity.

Calculate the Company’s Weighted Average Cost of Capital (WACC).

Explanation / Answer

Weighted average cost of capital (WACC) is the average of the minimum after-tax required rate of return which a company must earn for all of its security holders (i.e. common stock-holders, preferred stock-holders and debt-holders). It is calculated by finding out cost of each component of a company’s capital structure, multiplying it with the relevant proportion of the component to total capital and then summing up the proportionate cost of components. WACC is a very useful tool because it tells whether a particular project is increasing shareholders’ wealth or just compensating the cost.

Formula

For a company which has two sources of finance, namely equity and debt, WACC is calculated using the following formula:

WACC = r(E) × w(E) + r(D) × (1 – t) × w(D)

Cost of equity

In the formula for WACC, r(E) is the cost of equity i.e. the required rate of return on common stock of the company. It is the minimum rate of return which a company must earn to keep its common stock price from falling. Cost of equity is estimated using different models, such as dividend discount model (DDM) and capital asset pricing model (CAPM).

After-tax cost of debt

In the WACC formula, r(D) × (1 – t) represents the after-tax cost of debt i.e. the after-tax rate of return which the debt-holders need to earn till the maturity of the debt. Cost of debt of a company is based on the yield to maturity of the relevant instruments. If no yield to maturity is available, the cost can be estimated using the instrument's current yield, etc. After-tax cost of debt is included in the calculation of WACC because debt offers a tax shield i.e. interest expense on debt reduces taxes. This reduction in taxes is reflected in reduction in cost of debt capital.

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