CALCULATING THE COST OF CAPITAL Focus WACC and alternatives Rationale and calculation related to breaking points WMCC IOS PS – See page 521 of Chapter.

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CALCULATING THE COST OF CAPITAL Focus WACC and alternatives Rationale and calculation related to breaking points WMCC IOS PS – See page 521 of Chapter 11

CALCULATING THE COST OF CAPITAL Weight Average Cost of Capital Proportion of capital finance for each capital type multiplied by its related cost or required rate of return NB – the proportions should equal one (although the final WACC must not!) Weighting  Market weights (preferred)  Historical weights  Historical weights – actual *  Target weights – desired * Example

CALCULATING THE COST OF CAPITAL Weighting scheme Target market value is preferred Choice of weights not necessarily critical Economic Value Added (EVA) Difference between NOPAT and cost of funds used in finance  Cost here worked out by multiplying the Rand amount of funds drawn by the WACC

CALCULATING THE COST OF CAPITAL Economic Value Added In Practice box worthwhile here IRR but in Rands/Dollars Weighted Marginal Cost of Capital The firms WACC BUT based on the next Rand of finance Similar to the economic concept of ‘Marginal Revenue’ Increasing function of the level of total new financing Diagram on page 517

CALCULATING THE COST OF CAPITAL Weighted Marginal Cost of Capital Need to work out the breakeven points to find when levels change BP = AF/w AF = Amount of funds at a certain cost w = capital structure weight Example on page 516 – refers back to page 512 Table 11.1 for info The calculation is meant to determine if the ratios of capital are kept in sync but with the cheapest sources used first

CALCULATING THE COST OF CAPITAL Weighted Marginal Cost of Capital Work out the breakeven points based on information of capital weighting and amount available Then must work out average cost of capital over the ranges – WMCC Schedule Can you see that the WACC is acting like a step cost? Look at Table 11.2 It’s holding the weightings constant but the cost of debt and capital is rising

CALCULATING THE COST OF CAPITAL Investment Opportunities Schedule (IOS) Bring the IOS in now Table 11.3 Diagram 11.2 As long as IOS line stays above the WMCC line those projects are viable

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