The WACC ProjectInstructions
The assignment is to estimate the weighted average cost of capital (WACC) for an actual corporation as of the current time. Actual managers would need to know their company’s WACC as a starting point to estimate the discount rate to use in the net present value analysis of new projects (or of termination decisions). You may need to know the technique for application in some case study solutions.
The project also develops student skills in using elementary financial management models, in dealing with situations where there are too much or too little data, in employing publicly available data sources with little guidance, and in applying sound judgment when encountering naturally occurring measurement errors.
The project is scored out of 100 points. It is worth 10% of your total grade. Grading will be strict: follow the guidelines for a “good” grade.
15 points: Clear presentation of the data needed to estimate the WACC.
25 points: Avoiding major errors that renders your WACC estimate useless. This includes recognizing when a certain method of estimating the cost of capital for a financing source is not correct.
60 points: The totality of the rest of your project, including all of the components, and following the directions outlined in this document.
Picking Your Corporation
The theory of why managers should use the WACC in net present value analysis comes later in the course. For now, start with the equations for WACC, per se:
ka = (E/V)*ke + (B/V)*kd*(1 – t) 
V = E + B
kais the required rate of return on the firm’s assets, which is the same as WACC.
keis the firm’smarginal cost of common equity.
kd is the firm’s marginal cost of debt.
V is the total market value of the corporation. (not explicitly in the textbook)
E is the market value of outstanding common equity.
B is the market value ofoutstanding notes, debt, bonds, debentures, mortgages, and other interest-bearing securities.
t is the marginal tax rate the firm faces.Given the new tax code, use t = .21 for your project.
Method 1: Try to find the yield to maturity on your firm’s long-term debt. Try google and see what you find.
Method 2: Try to find your corporation’s Standard and Poor’s issuer debt rating. Again, try google. Then look on page 205 in your textbook at the table and estimate an appropriate rate. For example, if you find the rating is “AA-“, which would fall between AA and A, you may decide to choose 4.5% (which is between the 4.40 %and 4.62% in the 25-year section)
Method 3 (optional): If method 1 and 2 provide nothing, first double check to make sure your firm has long-term debt, and then follow steps 1 and 2 for a close competitor of your firm, and then make a judgment call on a estimate of Kd for your firm.
If the rating is junk [BB, B, and CCC], you have to creatively add a premium to the BBB interest rate.
Method 4:kd = rf + premium
In this method, add a premium to the risk-free rate (Rf).(See below for how to obtain Rf). You can use information from page 205 to guide you. For example, let’s say you did not find your firm’s issuer credit rating, you can make an educated guess of what it would be, and then add an appropriate premium to Rf. For example, if you guess the credit rating should be an A, the difference in the 25-year row of page 205 is 1.81 percentage points (4.62% – 2.81% for the Treasury). Take the Rf rate and add 1.81% to it for your estimate of Kd.
A note on Rf:
Experts disagree on what to use to the first riskfree rate, rf. Pure theorists insist on the Treasury Bill rate; November 30, 2009 reveals this datum to be 0.0005. Some pragmatists recommend that since the CAPM uses annual rates, rf should be the one-year rate of about 0.0040. Pure pragmatists argue that since WACC is used to judge long-term projects, rf should be the longest T-Bond rate. Still others argue that a T-Note is best. I suggest you use the “^TYX”, which is the long-term bond rate. Go to Yahoo Finance and type in ^TYX in the symbol field. The number that is shown, say 2.95, implies Rf is 2.95%.
You now have several estimates of Kd for your firm. Pick a final estimate and justify it for your final calculation.
ke = kd + ρremium 
Here, ρremium, is a subjectively estimated risk premium: given that an investor in your corporation can with some safety earn kdinvesting in debt, how much more should the investor expect to earn from investing in your corporation’s risky equity? Experience has shown that ρremium ranges from 0.02 to 0.10.
For the firm you have chosen, think about the nature of its business operations. Make a subjective assessment of the risk (and defend it in your project) and add a premium.
ke = (D1/Po) + g 
In this model, D1, is annual dividend per share that is expected to be paid next year, Po is the current common stock price, and g is the anticipated growth rate of dividend far into the future.
To estimate g, go to Yahoo Finance and
Using the financial calculator to find I/YR(or our potential estimate for g in this exercise), I
N = 4
I/YR = ? =
PV = -.94
FV = 1.52
PMT = 0
I/YR = 12.76, or 12.76%. This is way to high for an annual growth rate to persist forever, as is needed to apply the Gordon constant growth model, so I will not use this method to estimate Ke.
ke = rf + β(market risk premium)
Rf we discussed above.
There are many Internet sources for beta, β, the measure of how volatile your stock price is relative to the market as a whole. The estimates are likely to differ because of differing assumptions used in the beta calculation. Use the estimate 4rom Yahoo! Finance. Type in the symbol, and on the summary page, Beta is right there.
For market risk premium, we apply a pragmatic approach. Professor Pablo Fernandez communicated with hundreds of Finance professors worldwide and reviewed 150 textbook recommendations. His conclusion is that the0.057 is a recent best estimate of the market risk premium, rm – rf. Please use this figure.
Note: Many times β is low or even negative. Plugging the low beta in often will yield a marginal cost of equity estimate that violateske>kd. Other situations have arisen where β is unreasonably high — a beta value of 19 yielded a ke over 200%. You might find a negative β that will give you an unreasonably low keestimate. Many essentials of finance textbooks imply that the CAPM cannot fail as an estimator. It is a valuable tool for estimating ke, but, as you see, using it does involve subjectivity and it can yield unsatisfactory estimates. Use your judgment!
You now have several estimates of Ke for your firm. Pick a final estimate and justify it for your final calculation.
The easy one is equity. It’s simply:
E = price per share x number of shares outstanding 
A good one is Yahoo! Finance. Type in your firm’s symbol and look at marketcap on the Summary tab. That is the answer.
(Total debt – current liabilities) from the most recent balance sheet. Go to Yahoo Finance à Financials à Balance Sheet to find this.
V = E + B 
Apply equation :
ka = ke(E/V) + kd(1 – t)(B/V) 
Recall, t = .21 now.
ke = 0.0454 + 0.998(0.0499) = 0.0952 = 9.52% Good!
Now suppose the student uses the T-Bond rate of 4.54% improperly:
ke = 4.54 + 0.998(0.0499) = 4.59 = 4.59% = ridiculous
 The coupon rate or stated interest rate on existing debt is not kd. Notice I have repeated this many times. Don’t make this mistake! And you should know why……