Self Case - Student Educational Loan Fund, Inc.

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%.

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.

Finally we calculate the WACC. The formula is leveraged beta * (cost of capital) + Debt to capital * (cost of debt) * (1-tax rate). Then we get for the U.S. WACC= 6.48% and for Pakistan WACC= 15.93%.

WACC= (%of debt) (after-tax cost of debt) + (% of preferred stock)(Cost of preferred stock) + (% of common equity) (Cost of common equity)

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:

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, ).

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

in which wd is the proportion of Southwest’s assets financed by debt, ws is the proportion of Southwest’s assets financed by equity, rd is the required return on debt, rs is the required return on equity, and T is Southwest’s marginal tax rate.

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%.

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

Most of the corporations calculate WACC for giving investors an estimate on profitability and for being able to weight future projects. We are presented with Boeing current bonds, which constitute the long term debt portion of capital, and with Boeing’s assets which constitute the equity portion of capital. No other weighted entities (such as preferred shares) are considered. The debt/equity ratio would help with the calculation of weights. Boeing would need to earn at least 15.443% return on its investments (including the 7E7 project) in order to maintain the actual share price.

DebtThe first component of a firms WACC is its cost of debt. This is the effective rate that a company pays on its current debt. Because interest expenses on debt are deductible, the after-tax cost is used in its calculation. Cost of debt is calculated by multiplying the before-tax rate by one minus the marginal tax rate. As given in the Silicon Valley case assignment handout, SIVMED's long-term debt consists of 9.5% coupon, semiannual payment bonds with 15 years to maturity. The bonds last traded at a price of $891.00 per $1,000 par value bond. Given this data, SIVMED's cost of debt is calculated at 6.6% .

WACC = (1-corporate tax rate)(Pretax rate of cost of debt)(Market value of debt/ D+E))+ After tax rate of cost of equity(market value of equity/D+E))

Thus the WAVG Cost of Debt (including L/T debt and preferred stock) = rd = 8.633%

If company doesn’t have any debt, it means that WACC is equal to cost of equity.