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Weighted Average Cost of Capital The Weightings Factors Controlled by the Firm Factors External to the Firm Making Risk Adjustments Problems with WACC The WACC Introduction to the Cost of Capital > The WACC Free to share, print, make copies and changes. Get yours at ect&utm_source=boundless

The WACC is the minimum rate of return a company must earn on a new venture in order to make the investment worthwhile. The various securities that companies use as sources of finance are expected to generate different returns. To calculate WACC, multiply the cost of debt by the ratio of debt to total market value of the company. Then add this to the cost of equity multiplied by the ratio of equity to total market value. Weighted Average Cost of Capital Free to share, print, make copies and changes. Get yours at capital ?campaign_content=book_192_section_90&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boun dless WACC Equation View on Boundless.com Introduction to the Cost of Capital > The WACC

The WACC must take into account the weight of each component of a company's capital structure. The calculation of the WACC usually uses the market values of the various components rather than their book values. Market value is the price at which an asset would trade in a competitive auction setting. Book value refers to the value of an asset according to the account balance present on the balance sheet of a company. If the value of a company's debt exceeds the value of its equity, the cost of its debt will have more "weight" in calculating its total cost of capital than the cost of equity. If the value of the company's equity exceeds its debt, the cost of its equity will have more weight. The Weightings Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_90&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Domestic Balance Sheet View on Boundless.com Introduction to the Cost of Capital > The WACC

Capital structure refers to the way a company finances its assets through some combination of equity, debt, or hybrid securities. When a higher proportion of debt is chosen, the cost of debt must factor in credit risk. Changes in a company's dividend policy provide information to investors, who should react accordingly to either increase or decrease the value of an asset. Factors Controlled by the Firm Free to share, print, make copies and changes. Get yours at firm ?campaign_content=book_192_section_90&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boun dless Expected Investor Return View on Boundless.com Introduction to the Cost of Capital > The WACC

Since debt expense is tax-deductible, the cost of debt is computed as an after tax cost to make it comparable with the cost of equity. The Federal Reserve moderates long-term interest rates, which causes fluctuations in the risk-free rate that affect the cost of capital. Economic conditions refer to the demand and supply of capital in the marketplace that can impact how capital is raised, and therefore what the cost of capital will be. Market conditions refer to the demand for higher rates of return by investors, which will increase the cost of capital. Factors External to the Firm Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_90&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boun dless U.S. Corporate Taxes View on Boundless.com Introduction to the Cost of Capital > The WACC

It is possible to adjust risk by figuring the differing risk into the company's beta. The beta coefficient is the risk of a new project in relation to the risk of the market as a whole. Therefore, if a new project of differing risk is undertaken, the beta for that project will be weighted into the company's overall cost of capital. Making Risk Adjustments Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_90&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boundl ess Beta Equation View on Boundless.com Introduction to the Cost of Capital > The WACC

While the relative debt and equity values can be easily determined, calculating the costs of debt and equity can be problematic. The problem inherent in different methods used to calculate cost of equity is that at least one component is an estimate. The terms of risk-free bonds used in determining cost of debt may not always adequately match the terms of the company's debt. Problems with WACC Free to share, print, make copies and changes. Get yours at ?campaign_content=book_192_section_90&campaign_term=Finance&utm_campaign=powerpoint&utm_medium=direct&utm_source=boun dless U.S. Treasuries Yield View on Boundless.com Introduction to the Cost of Capital > The WACC

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Key terms business risk The risk associated with the operational and administrative procedures of the particular industry or company. capital intensity ratio the amount of fixed or real capital present in relation to other factors of production, especially labor covariance A measure of how much two random variables change together. default To fail to meet an obligation. financial risk An umbrella term for multiple types of risk associated with financing, including financial transactions that include company loans in risk of default. inflation An increase in the general level of prices or in the cost of living. lobbying The act of attempting to influence decisions made by officials in the government, most often legislators or members of regulatory agencies. proxy A measurement of one physical quantity that is used as an indicator of the value of another. proxy fight a conflict where two powers use third parties as a supplement to, or a substitute for fighting each other directly retained earnings The portion of net income that is retained by the corporation rather than distributed to its owners as dividends. Synergy Benefits resulting from combining two different groups, people, objects, or processes. Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital

Domestic Balance Sheet If the person analyzing a company chooses or if the market value of a company's debt and equity is not available, the book value can be used. The book value of debt and equity can be found on the company's balance sheet. Free to share, print, make copies and changes. Get yours at Wikimedia. "DWBA DBS." CC BY-SA View on Boundless.comCC BY-SA 3.0http://commons.wikimedia.org/wiki/File:DWBA_DBS.jpgView on Boundless.com Introduction to the Cost of Capital

WACC Equation In this formula, V is equal to the value of the firm, or Debt (D) plus Equity (E). r(D) is the company's rate on debt, r(E) the rate on equity. T is the company's marginal tax rate. Free to share, print, make copies and changes. Get yours at Wikibooks. "Principles of Finance/Section 1/Chapter 6/Corp/WACC." CC BY-SA View on Boundless.comCC BY-SA on Boundless.com Introduction to the Cost of Capital

Expected Investor Return To calculate expected investor return, divide the dividend payment per share by the market price of the asset and add the expected growth rate. Free to share, print, make copies and changes. Get yours at Wikipedia. "Cost of capital." GNU FDL View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Cost_of_capitalView on Boundless.com Introduction to the Cost of Capital

U.S. Corporate Taxes Effective U.S. corporate tax rates from Free to share, print, make copies and changes. Get yours at Wikimedia. "US Effective Corporate Tax Rate v2." CC BY-SA _v2.jpg View on Boundless.comCC BY-SAhttp://commons.wikimedia.org/wiki/File%253AUS_Effective_Corporate_Tax_Rate_ _v2.jpgView on Boundless.com Introduction to the Cost of Capital

U.S. Treasuries Yield Yields on 1-mont, 10-year, and 30-year U.S. government debt. Free to share, print, make copies and changes. Get yours at Wikimedia. "US Treasury bills and bonds yield." CC BY-SA View on Boundless.comCC BY-SAhttp://commons.wikimedia.org/wiki/File%253AUS_Treasury_bills_and_bonds_yield.pngView on Boundless.com Introduction to the Cost of Capital

Beta Equation The beta of an investment is equal to the covariance between the rate of return of the investment, r(a), and that of the portfolio, r(p). Free to share, print, make copies and changes. Get yours at Wikipedia. "Beta (finance)." GNU FDL View on Boundless.comGNU FDLhttp://en.wikipedia.org/wiki/Beta_(finance)View on Boundless.com Introduction to the Cost of Capital

Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital Which of the following is NOT a way weighted average cost of capital (WACC) is used to analyze a company's financial activities? A) WACC is the rate a company is expected to pay, on average, to its security holders. B) WACC is the minimum rate of return a company must earn on a new venture. C) All of these answers. D) WACC influences how a company's capital structure is balanced.

Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Introduction to the Cost of Capital Which of the following is NOT a way weighted average cost of capital (WACC) is used to analyze a company's financial activities? A) WACC is the rate a company is expected to pay, on average, to its security holders. B) WACC is the minimum rate of return a company must earn on a new venture. C) All of these answers. D) WACC influences how a company's capital structure is balanced.

Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital Suppose that a company has total financing where 10% comes from bonds, 10% from a loan, and 80% from shareholders’ equity. The bonds pay on average a 10% interest rate, the loan has a 10% interest rate, and shareholders require a 10% return. The interest payment on the loan is tax deductible and the tax rate is 20%. What is the simple average cost of capital equal to? A) B) C) D) 0.1

Free to share, print, make copies and changes. Get yours at Saylor OER. "Business Administration « Saylor.org – Free Online Courses Built by Professors." CC BY BY 3.0http:// Introduction to the Cost of Capital Suppose that a company has total financing where 10% comes from bonds, 10% from a loan, and 80% from shareholders’ equity. The bonds pay on average a 10% interest rate, the loan has a 10% interest rate, and shareholders require a 10% return. The interest payment on the loan is tax deductible and the tax rate is 20%. What is the simple average cost of capital equal to? A) B) C) D) 0.1

Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital Suppose that a company has total financing where 10% comes from bonds, 10% from a loan, and 80% from shareholders’ equity. The bonds pay on average a 10% interest rate, the loan has a 10% interest rate, and shareholders require a 10% return. What is the weighted average cost of capital (WACC) equal to? A) B) 0.3 C) 0.1 D)

Free to share, print, make copies and changes. Get yours at Saylor OER. "Business Administration « Saylor.org – Free Online Courses Built by Professors." CC BY BY 3.0http:// Introduction to the Cost of Capital Suppose that a company has total financing where 10% comes from bonds, 10% from a loan, and 80% from shareholders’ equity. The bonds pay on average a 10% interest rate, the loan has a 10% interest rate, and shareholders require a 10% return. What is the weighted average cost of capital (WACC) equal to? A) B) 0.3 C) 0.1 D)

Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital The weighted average cost of capital "weighting" is based on _____. A) the book value of the company's debt and equity. B) the market value of the company's debt and equity. C) the company's tax rate. D) the company's returns on equity and debt.

Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Introduction to the Cost of Capital The weighted average cost of capital "weighting" is based on _____. A) the book value of the company's debt and equity. B) the market value of the company's debt and equity. C) the company's tax rate. D) the company's returns on equity and debt.

Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital Which of the following correctly explains how a specific factor can influence a company's weighted average cost of capital? A) If a company increases it dividends, it leads to an increase in its WACC. B) Increasing the amount of debt generally improves performance and increases return on equity. C) Increased fixed costs will decrease a company's WACC. D) All of these answers.

Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Introduction to the Cost of Capital Which of the following correctly explains how a specific factor can influence a company's weighted average cost of capital? A) If a company increases it dividends, it leads to an increase in its WACC. B) Increasing the amount of debt generally improves performance and increases return on equity. C) Increased fixed costs will decrease a company's WACC. D) All of these answers.

Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital Which of the following are factors that influence the weighted average cost of capital (WACC) calculation and is external to the firm? A) The corporate tax rate. B) Changes in interest rates. C) The conditions in the stock market. D) All of these answers.

Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Introduction to the Cost of Capital Which of the following are factors that influence the weighted average cost of capital (WACC) calculation and is external to the firm? A) The corporate tax rate. B) Changes in interest rates. C) The conditions in the stock market. D) All of these answers.

Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital A company is considering investing in a project that requires the company to take on risks outside of the company's current scope. As a result, which of the following things will happen? A) The company does not have to recalculate its WACC to evaluate the project. B) The company's stock value would drop unless the project increase the company's expected returns. C) The project would decrease the company's cost of equity. D) All of these things.

Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Introduction to the Cost of Capital A company is considering investing in a project that requires the company to take on risks outside of the company's current scope. As a result, which of the following things will happen? A) The company does not have to recalculate its WACC to evaluate the project. B) The company's stock value would drop unless the project increase the company's expected returns. C) The project would decrease the company's cost of equity. D) All of these things.

Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital Which of the following is a problem associated with using the weighted average cost of capital? A) The calculation is not exact as at least one component is an estimate. B) All of these answers. C) WACC will vary for the same business based on which method you use. D) It may be difficult to find a risk-free rate that corresponds to the investment being analyzed.

Free to share, print, make copies and changes. Get yours at Boundless - LO. "Boundless." CC BY-SA BY-SA 3.0http:// Introduction to the Cost of Capital Which of the following is a problem associated with using the weighted average cost of capital? A) The calculation is not exact as at least one component is an estimate. B) All of these answers. C) WACC will vary for the same business based on which method you use. D) It may be difficult to find a risk-free rate that corresponds to the investment being analyzed.

Attribution OER Commons. CC BY-SA BY-SAhttp:// Wiktionary. "covariance." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/covariance Wikipedia. "Market value." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Market_value Wikipedia. "Balance sheet." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Balance_sheet Wikipedia. "Weighted average cost of capital." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Weighted_average_cost_of_capital Wikipedia. "Book value." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Book_value Boundless Learning. "Boundless." CC BY-SA BY-SA 3.0http:// Wikipedia. "Weighted average cost of capital." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Weighted_average_cost_of_capital Wiktionary. "proxy fight." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/proxy+fight Wiktionary. "proxy." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/proxy ICTQatar. CC BY-SA %2520final.pdfCC BY-SA %2520final.pdf OER Commons. CC BY BYhttp:// OER Commons. CC BY BYhttp:// Wikipedia. "Capital structure." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Capital_structure Wikipedia. "Credit Risk." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Credit_Risk Wiktionary. "default." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/default Wikipedia. "business risk." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/business%20risk Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital

Wikipedia. "financial risk." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/financial%20risk Wikipedia. "Cost of capital." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Cost_of_capital Wikipedia. "Weighted average cost of capital." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Weighted_average_cost_of_capital Wikibooks. "Principles of Finance/Section 1/Chapter 6/Corp/WACC." CC BY-SA BY-SA Wikipedia. "Capital intensity." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Capital_intensity Wiktionary. "retained earnings." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/retained+earnings ICTQatar. CC BY-SA %2520final.pdfCC BY-SA %2520final.pdf OER Commons. CC BY BYhttp:// OER Commons. CC BY BYhttp:// Wikipedia. "Cost of capital." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Cost_of_capital Wikipedia. "Federal Reserve System." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/Federal_Reserve_System Wiktionary. "inflation." CC BY-SA BY-SA 3.0http://en.wiktionary.org/wiki/inflation Wikipedia. "lobbying." CC BY-SA BY-SA 3.0http://en.wikipedia.org/wiki/lobbying Free to share, print, make copies and changes. Get yours at Introduction to the Cost of Capital