Use the That’s WACC. The Best WACC Calculator. to generate estimates of the weig
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Question
Use the That’s WACC. The Best WACC Calculator. to generate estimates of the weighted average cost of capital (WACC) for five different companies (pick companies from different industries such that you find a relatively wide range of WACC estimates): Build a three column table displaying the full company name and its stock symbol in the first column, a brief description of the company and its main line(s) of business in the second column, and the company’s WACC estimate (the value given in the From Financial Statements column) in the third column. Below your table, write an essay discussing the importance and process of calculating the weighted average cost of capital. The list below suggests some (though not all) of the topics that you should address in your paper: Why do firms need to know this value? How is the weighted average cost of capital used to make decisions? What are each of the components of the weighted average cost of capital and how are each of these components estimated? What are some possible reasons for why the WACC’s in your table differ from one another? Be sure to discuss the relationship between risk and expected return as reflected in bond and stock yields. (Please don't list Apple and Ford if possible)
Explanation / Answer
Table:
WACC is a very important financial tool for both the investors as well the company itself. A company uses the financial tool of WACC to make its investment decisions. In the capital budgeting process when a company has to make investments in a project it calculates its IRR (internal rate of return) and if IRR>WACC then the investment is considered viable, otherwise not. Also computation of metrics like NPV (net present value) and EVA (economic value added) also requires the use of WACC. Investors and financial analysts use WACC to calculate the value of a company. A company’s value is nothing but the present value of all future cash flows that are discounted by the company’s WACC.
The components of WACC are cost of equity, cost of debt and cost of preferred stock. The formula of WACC is WACC = (cost of equity*percentage of equity in total capital) + (after tax cost of debt*percentage of debt in total capital) + (cost of preferred stock*percentage of preferred stock on total capital).
It is to be noted that percentage of equity, percentage of debt and percentage of preferred stock is computed on the basis of market value of each of these components. Thus total value (V) = market value of equity (E)+market value of debt (D) + market value of preferred stock (P). % of equity = E/V, % of debt = D/V and % of preferred stock = P/V.
Cost of equity is estimated using the CAPM (capital asset pricing model). As per the model cost of equity = risk free rate + beta*(return on the market – risk free rate). Cost of debt is estimated on an after-tax basis since the interest payments are tax deductible. It is the effective rate a company pay’s on its current debt. Cost of debt is nothing but the yield to maturity of debt instruments like bonds. Cost of preferred stock is the annual preferred dividend divided by the market price per share.
WACCs in the above table are different because the different costs (like cost of equity, debt etc) is different for each company. Cost of equity depends on beta of a stock and beta is different for different stocks. Beta is nothing but the measure of volatility of a stock and the beta for each of the five companies discussed above are different. Cost of debt and cost of preferred stock also differs from one company to another. All these causes the WACC to be different for different companies.
There is a direct relationship and a positive correlation between risk and expected returns. The higher is the risk associated with a stock or a bond higher will be the expected return from that stock or bond. Thus the higher the risk of a financial instrument higher will be its cost.
Company name and stock symbol Brief description WACC estimate (in %) 1 Name : GE It is an American multinational conglomorate with business interests in aviation engines, health care equipments, power sector etc 5.39 Stock symbol: GE (NYSE) 2 Name: Tesla Inc. Tesla specializes in electric vehicles and solar panel manufacturing 6.27 Stock symbol: TSLA (Nasdaq) 3 Name: Amazon Inc. Amazon is an electronic commerce and cloud computing company 10.27 Stock symbol: AMZN (Nasdaq) 4 Name: P&G P&G is a multinational consumer goods company that is famous for its personal care products 4.63 Stock symbol: PG (NYSE) 5 Name: Pfizer Inc. Pfizer is a multinational pharmaceutical company that makes and sells drugs across the globe 8.49 Stock symbol: PFE (NYSE)Related Questions
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