Wacc Case

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.

Given that the cost of equity is 9.4% and the cost of debt is 12.2%, Star’s cost of capital can be calculated as 9.14% (Appendix B). The company was also considering raising the cost of debt to the industry average of 19%. At this cost of debt, Star Company would have a lower cost of capital of 8.24% (Appendix B) because interest on debt capital is deductible whereas dividend payments on equity capital are not.

Based on the suggestion that the focus should be on market values, compute the weights of debt, preferred stock, and common stock.

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

To calculate the cost of debt and equity for this project, we combined the risk-free rate with a risk premium based on the market risk premium and the riskiness of Southwest Airlines.

The debt/equity ratio for Boeing is provided in exhibit 10, 0.525, from where we can infer the weights of both debt and equity.

➢ How was cost of debt measured of each division? Should the cost of debt differ across three divisions? Why?

7. Debt to capitalization = Long-term Debt in Balance Sheet / Long term debt + Net Assets in

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

Taking the CAPM equation, we were able to figure out eh cost of equity and in its credit range

The effect of financial leverage on the cost of equity is prevalent in the Modigliani-Miller capital structure theory. Since the financial leverage increases the cost of equity, it can be considered one of the disadvantages of borrowing. As shown in Appendix A, the cost of equity, at each debt to capital ratio, increases by 0.1% as the financial leverage increases by 10%. With a higher

Weights of Debt and equity are 8.3 and 91.7%. Now, plugging all the values in, we can derive company’s Weighted Average Cost of Capital.

In general the three-stage approach allows us to add complexity to the standard dividend discount models by enabling changing growth scenarios throughout the forecasting period: an initial period of higher than normal growth, a transition/consolidation period of declining growth and final a period of stable growth. The main assumptions are that the company on which we conduct the calculation study currently is in extraordinary strong growth phase. The time period with the extraordinary strong growth must be strictly defined and eventually be replaced with the declining growth assumption. Lastly, Capital Expenditures and Depreciation are expected to grow at the same rate as revenues. .

And we calculated the weight of debt which was Weight of debt for P&S= [(13.1%+5.3%)/2]= 9.2%