The purpose of this memo is to provide Target Corp. senior management with an evaluation of the company’s weighted average cost of capital (WACC). Since the 2010 financial information is not yet to be finalized, the analysis will use the most currently published financial data to evaluate each component of the WACC, including the company financial structure, cost of debt, and cost of equity. I. Target Corp. Financial Structure
According to the consolidated balance sheet on January 30, 2010 (exhibit 1), the total amount of debt, including short-term and long-term debts and other current liabilities was at $16.814 billion. Account Payable is excluded from the WACC’s debt component because it is not a source of funding that comes from
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Also in exhibit 3, the average annual return of the 10-year Treasury bond during the same time period is 5.28%. Therefore, the spread between the average market return and the risk-free rate, or the equity market risk premium is 6.37%. * Stock Beta: Exhibit 5 shows a detailed measurement of the company’s stock returns in relation to the rest of the market through 5-year historical price and index data. The analysis includes monthly returns of both the NYSE and the S&P 500 index in order to capture a comprehensive view of the market return. In each comparison, the monthly returns of the Target stock and market are plotted on Y-axis and X-axis respectively to get the regression line’s slope or beta. The analysis arrives at an average beta of 0.988 which indicates a similar movement of Target stock’s returns in comparison to the whole market over time.
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.
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: Debt proportion | 31.7% | Cost of Debt | 5.06% | Corporate
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.
The cost of equity is the theoretical return that equity investors expect or receive from the company for investing their funds in the company. The risk free rate that is the Government Treasury bill rate is 3.1%, the market risk premium is 7% and the beta has been calculated as
The table below shows the equity betas for the firms presented in the case (using Jan-92 to Dec-96 equal weight NYSE/AMEX/NASDAQ as market portfolio):
Here we choose VW NYSE, AMEX, and NASDAQ data as market returns, because it’s value weighted and more reliable. The results show CSC’s equity beta = 2.27, QRG’s equity beta = 1.79.
10. What is the correct capital structure and weighted average cost of capital for discounting the investment’s free cash flow. Assume a 35% tax rate. A correct response requires that you define capital structure and Weighted Average Cost of Capital (WACC) with a formula. When defining a term with a formula be sure that all the variables are also defined.
The comptroller currently finds the weights for the weighted average cost of capital (WACC) from information from the balance sheet shown in Table 2. Compute the book value weights that the comptroller currently uses for the company’s capital structure.
WACC= (%of debt) (after-tax cost of debt) + (% of preferred stock)(Cost of preferred stock) + (% of common equity) (Cost of common equity)
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.
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.
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 common practice to determine the firm’s beta is to draw from historical data from published sources or compare numbers to competitors. In this case, Heinz can compare to Kraft, Campbell Soup and Del Monte and use professional judgement in determining the stock’s sensitivity to the market. A stock’s beta can be determined using a formula as well.
WACC calculations entailed several different steps prior to using the actual WACC formula. First, by using CPP’s balance sheet we identified its D/E, by dividing Debt portion by the Equity portion arriving at 2.07, than we calculated D/V – 0.67 and E/V – 0.33. Afterwards, we used comparable firm Wackenhut’s capital structure for our analysis and applied it to our calculations. Wackenhut’s capital structure consisted of 92% equity and 8% debt. Subsequently, we went through the Beta unlevering and then levering process using above capital structure. To unlever, we multiplied given beta of 0.89 by the debt portion of capital structure 0.92, than we relevered the Beta_e=(1+D/E 2.07) * unlevered Beta 0.82 = 2.51. Next step consisted of calculating R_e=R_f+beta_e*MRP= 8.6%(given)+2.51*7.5% (given)=27.41%.
Despite this change in price, the Weighted Average Cost of Capital (WACC) will give a more accurate representation of what the change in capital structure implies for the firm, by taking account the costs of debt.
With all the above aspects considered, Adecco arrived at a debt portion of WACC equal to .96% and an equity portion of 9.31% resulting in an overall WACC of 10.27%. This was calculated utilizing a beta of equity considering a beta of debt and assets of 0.2 and 0.48 respectively. Utilizing the free cash
Weighted Average Cost of Capital (WACC) is a fiscal barometer to gauge a business cost of capital. In this sense, the WACC supplies at discount