Finance: Weighted Average Cost of Capital and Market Risk Premium

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%.

Before moving forward to compute the present value of these cash flows, a terminal value is required to forecast the long term value of the company after 5 years. . Following formula is used to calculate the terminal value.

What is the correct capital structure and weighted average cost of capital for discounting the investment’s free cash flow?

We use Capital Asset Pricing Model (CAPM) approach to calculate the cost of equity. The formula of CAPM is re = rf + β × (E[RMkt] – rf).

9. What is the Cost of Debt, before and after taxes? Using the interest rate for the largest debt…cannot use the weighted interest rate for the debt since it includes capital lease obligations with no stated rate and could not find in the notes to the financials. 5.4% After tax cost is .054 x (1-.36) = 3.5%

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:

I used WACC as the discount factor, we expect the rate of return to be higher than it, the same at least. The WACC reflects the average risk and overall capital structure of the entire firm [2]. It’s the required return and it presents how much the company pays for the capital it finances. In this case, the cost of equity is 10.33%, the cost of debt is 6.50%. I calculated WACC using those numbers and got a result of 8.49%.

-Jensen's Travel Agency has 9 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 15 percent and the firm's tax rate is 34 percent. What is Jensen's cost of

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 November 2001, the costs of required rates of return on debt in the capital market are as follows:

WACC = Cost of Debt X proportion of debt + Cost of Preferred Stock X Proportion of preferred stock + Cost of equity X proportion of equity

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

A key factor in determining a project's viability is its cost of capital [WACC]. The estimation of Boeing's WACC must be consistent with the overall valuation approach and the definition of cash flows to be discounted. Note that this process is a forward looking focus and is laden with uncertainty. It is how the assumptions are modeled that many costly mistakes can be made. While finding a rate of return for an individual project, it is important to remember that WACC is only appropriate for an individual project.

3. If Lex had no debt in its capital structure, what would be its cost of capital? How could this estimate be used to value Lex? If Lex operated with essentially no leverage in its capital structure and then added a moderate amount of debt, how would this affect its total value? How might we capture this value impact of debt in our valuation analysis?

After calculating the Total Cash Flow for all three scenarios, the Internal Rate of Return (IRR) and Net Present Value (NPV) for the project can be calculated as well. See Question 3 for details regarding WACC calculation. The IRR and NPV for each scenario are shown in Table 4 below: