Calculating the WACC
- Market values or book values?
- Book values are historical
- Market values reflect current requirements
Note that retained earnings are ignored in WACC
- Before or after tax?
- Before-tax WACC for before-tax cash flows
- After-tax WACC for after-tax cash flows
- Which tax rate to use?
Calculating the WACC
- To find the average cost of capital, we weight individual costs of capital by their proportions in the firm’s capital structure
E = value of equity D = value of debt
E/(E+D) is the proportion of equity
D/(E+D) is the proportion of debt
Calculating the WACC
- Cost of equity: Ke = 16.9%
- Cost of preference shares: Kp = 13.4%
- Cost of irredeemable debt: Kid = 9.7%
- Cost of redeemable debt: Krd = 8.7%
- Cost of bank loans: Kbl = 8.8%
Note that the relative costs of the different sources reflect their relative risks, i.e. reflect the risk-return hierarchy of financial securities.
Calculating the WACC
Weighting by market values (see textbook)
- Equity: 16.9% x 633.6/871.5
- Preference shares: + 13.4% x 33.5/871.5
- Irredeemable debt: + 9.7% x 68.4/871.5
- Redeemable debt: + 8.7% x 76.0/871.5
- Bank debt: + 8.8% x 60.0/871.5
= 14.9% = WACC
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