At first, WACC and CAPM was attempted to be used as a source of cost of capital. However, for WACC, there is no available proportion of debt and cost of debt for MW. For CAPM, no available data seems to support the acceptable
WACC = (Weight of Equity * Equity Cost of Capital) + (Weight of Debt * Debt Cost of Capital)
General speaking, WACC is the rate that a company’s shareholders expect to be paid on average to finance its assets, and it is the overall required return on the firm as a whole. Therefore, company directors often use WACC to determine whether a financial decision is feasible or not. In this case, I will choose 9.38% as discount rate. The reason why I choose 9.38% as discount rate is because the estimated Debt/Equity is 26% under the assumptions by CFO Sheila Dowling, which is most close to 25% of Debt/Equity from the projected WACC schedule. There might be some flaws existing by using WACC as discount rate. As we know, the cost of debt would be raised significantly as the leverage increased. The investment will definitely increase the firm’s current debt. So, the cost of debt would not keep at 7.75%.
According to reported in The News, 65 countries are the part of One Belt, One Road project and 60% of world’s GDP is contributing by these countries this will have an impact on Pakistan’s economy too as Pakistan has become center of attraction for many foreign investors after CPEC.
1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow.
Then we can use the following formula to calculate the WACC. The cost of debt is taken to be on an after tax basis to further to account for the depreciation tax shield.
According to the company’s annual report in 2009, the Federal statutory tax rate is 35%. Along with the above analysis, we have gathered all the key information necessary to estimate the WACC as following:
Since this project is a going concern, the levered terminal and present values are calculated using the weight average cost of capital (WACC) as the discount rate, which we calculate to be 16.17%.
In order to find the WACC, we need to find the cost of the components of the capital structure and their proportion in the total capital.
* We already know the new is the interest rate of debt (5.5%). We use the average industry level (40.1%) as ATC’s D/E ratio like discussed in case page 7. By, we can get the new (9.46%).
Lastly, the interest rate was calculated by dividing interest expense by long-term debt for the company. These numbers, along with equity and debt data given to us in the case, resulted in a WACC of 13.89%.
When we calculate those number, we need to know the equity and debt of the company which can easily find on yahoo finance. The cost of debt and the corporate tax rate that we calculated are also based on the data from yahoo finance. We made Beta for the companies with 10 year ranges and use it to calculate return of equity. After we got those number, we can calculate the WACC.
WACC (Weighted Average Cost of Capital) is a market weighted average, at target leverage, of the cost of after tax debt and equity.
The risk premium should be calculated by using holding-period returns, as 9.90%-3.48%= 6.42%. Then we can compute the cost of equity is 3.48%+0.97*(6.42%) =9.71%. According to Exhibit1, 1987, we calculate the tax rate by dividing income tax over EBIT. $175.9/$398.9=44%. Then we can calculate the firm’s WACC = (1-44%)*(9.34%)*60%+9.71%*40%=7.02%.
The structure of a project’s financing depends on the industry the transaction is taking place, the underlying business model and in particular the allocation of risks and responsibilities between the individual partners (Weber & Alfen, 2010).