Best Practices in Estimating the Cost of Capital: Survey and Synthesis

• Cost of capital must reflect current capital market conditions (current required returns) • Cost of capital must also reflect the optimal relative proportions of debt and equity the firm will

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

Barb Williams and Rick Thomas, while attending an executive education course at a well-known business school, came across a case which involved calculating the cost of capital for Telus Corporation (Telus). Basic data such as the Balance Sheet, Income Statement, Data on Telus’ Common Stock, Market Index, and the Average Annual Returns in North American Capital Markets were provided. In order to calculate Telus’ cost of capital we need to calculate the company’s Cost of Equity, Cost of Debt, and Tax Rate along with their weighted cost and then apply these to the Weighted

Calculating a firm’s cost of capital has always been a key issue in financial management. To tackle this issue, WACC is one of the most widely used formulas even though the process is difficult, and results seem ambiguous. However, it is clear that WACC is the average cost of capital the firm must pay, in this case Home Depot (HD), to all its investors, both debt and equity holders. Since HD has debt to the tune of $29.6 billion (2012), it means that rwacc is an average of its debt and equity cost of capital. Based on the limiting factors revealed on the page 5, our confidence level in HD’s WACC is moderate. Nevertheless, since HD’s WACC is 5.97% it means that the company should only invest in projects

Given these approximations, the CAPM model would total the risk-free rate and the market risk premium times beta to arrive at a cost of equity of 9.68%, which reflects the investors’ expected return from investing in shares of the company.

So in order for the company to make a smart decision, they would have to use the WACC (weighted average cost of capital) in order to determine which way they would go about raising that additional capital, whether it be equity (shares of stocks) or debt (a bond issue).

In practice, the factors affecting cost of capital include capital structure policy, dividend policy, investment policy, level of interest rates and tax rates.

Cost of Equity = Risk free rate + (Market return – risk free rate) X beta

The mixture of debt-equity mix is important so as to maximize the stock price of the Costco. However, it will be significant to consider the Weighted Average Cost of Capital (WACC) as well so that it can evaluate the company targeted capital structure. Cost of capital (OC) may be used by the companies as for long term decision making, so industries that faced to take the important of Cost of capital seriously may not make the right choice by choosing the right project(Gitman’s, ).

Moreover, let’s calculate the Weighted Average Cost of Capital (WACC). And in order to calculate it we need to know the capital structure of the company. Knowing the capital structure of the

1. Please define Weighted Average Cost of Capital (WACC). Write down the WACC formula, and discuss its components.

The following case analysis portraits the use of capital asset pricing model to compute the weighted average cost of capital for Marriott and each of its divisions. The flow of events below is following a string of different evaluations, each of which is assessed separately.

Cost of Equity is the return that stockholders require for a company. A company’s cost of equity represents the compensation that the market demands in exchange for owning the assets and bearing the risk of ownership. Based on capital markets the cost of equity varies in direct relation to the assumed risk in that specific market. The distinctive of the firm is the sensitivity to market risk (β) which depends on everything from management to its business and capital structure. Therefore past performances and present conditions have a direct effect on the overall value. Applying calculations at a divisional level allows specified markets to be analysis based on present market conditions for that service or product. The formula used to calculate Cost of Equity is:

3) What is the weighted average cost of capital and why is it important to estimate it? Is the

The Weighted Average Cost of Capital (WACC) is the discount rate used in a Discounted Cash Flow (DCF) analysis to present value projected free cash flows and terminal value.