Weighted Average Cost of Capital

Download Weighted Average Cost of Capital Powerpoint Presentation

By downloading this powerpoint presentation file, you agree to our terms of use. If you interesting in "Weighted Average Cost of Capital" powerpoint themes, you can download to use this powerpoint template for your own presentation template. For viewing only, you can play with our flash based presentation viewer instead of downloading the ppt file.

Weighted Average Cost of Capital Outline

Weighted Average Cost of Capital WACC copyright anbirts 1

WACC • The Capital of a company or organisation is made up of two elements • Long Term Debt and • Equity• To find the WACC we simply weight the cost of each by its proportion in the total copyright anbirts 2

WACC • The cost of Debt is easy to find out• We ask a bank• (NB It is the after tax cost of Debt that we need) • The cost of Equity, as we have discussed is trickier copyright anbirts 3

WACC – An Example • Company A has 50% of its capital in Equity and 50% in Debt • Cost of Debt is 7%• Tax rate is 25%• Risk Free Rate is 5%• Premium on the risk free rate is 4%• Company Beta is 1.4575 copyright anbirts 4

WACC – Calculation • Debt• {7 (1-.25)}= 5.25 x .5 = 2.63 • Equity ER R + (ER – R )B A = F M F 5 + (9 – 5)1.4575 =10.83 x .5 = 5.42 WACC 8.05 copyright anbirts 5

WACC • This assumes steady state i.e. same risk, same financing and so on • What if we are doing something new?• Problems – No history, no Beta – We need a proxy copyright anbirts 6

WACC – Proxy • When using a proxy we need to be careful • How close is it in Business risk and Experience terms? • How close is it in Financial risk terms? copyright anbirts 7

WACC –Adjusting for Financial Risk • Using a ‘leveraged’ or ‘geared’ proxy• If we intend to finance our project using different proportions of Debt and Equity to those used by our proxy company we have to adjust the proxy Beta to account for the difference in Financial risk copyright anbirts 8

WACC –Adjusting Proxy Beta • Two equations• No 1. To ‘un-lever’ a levered proxy• B = . B . JU J [ 1 + D (1-T )] C EB = un-leveraged beta, B = leveraged beta JU J D/E = Debt Equity ratio, T = Tax rate C copyright anbirts 9

WACC –Adjusting Proxy Beta • No 2. To lever an un-levered beta • B = B [ 1+ D (1-T )] J JU C E copyright anbirts 10

WACC –Adjusting Proxy Beta Example • Proxy company beta = 1.3• Proxy company tax rate = 25%• Proxy company D/E = .3• Our Company tax rate = 25%• Our intended D/E = .5 copyright anbirts 11

WACC – Adjusting Proxy Beta Example • BJU = 1.3 = 1.3 = 1.061 1 + .3(1-25) 1.225 • BJ = 1.061[1+.5(1-.25)] = 1.4575 copyright anbirts 12