ACCT 515 – Weighted Average Cost of Capital

ACCT 515 – Weighted Average Cost of Capital

Subject: Business    / Finance
Question
Second Project

The purpose of this project is for you to have some practice working with financial concepts in the real world. This will involve integrating some material from throughout the course. The project will also involve the development of your own approach to doing the work. The project does not provide a step-by-step procedure for you to follow.

Your task is to determine the WACC for a given firm using what you know about WACC as well as data you can find through research. Your deliverable is to be a brief report in which you state your determination of WACC, describe and justify how you determined the number, and provide relevant information as to the sources of your data.

With the help of your professor, you have selected a company for which to research and find the WACC. Your research is to be independent from any information you may find at thatswacc.com or similar sites although you might want to use such sites to provide a reasonableness check on the WACC you calculate.

Assumptions

As you recall, the formula for WACC is

rWACC = (E/E+D) rE + D/(E+D) rD(1-TC)

The formula for the required return on a given equity investment is

ri= rf + ?i * (RMkt-rf)

RMkt-rfis the Market Risk Premium. For this project, you may assume the Market Risk Premium is 4% unless you can develop a better number.

rfis the risk free rate. The YTM on 10 year US Treasury securities is a good approximation.

You may assume a corporate tax rate of 40%.

One good source for financial data for companies as well as data about their equity is.yahoo.com/”>http://finance.yahoo.com. By looking around this site, you should be able to find the market capitalization (E) as well as the ? for any publicly traded company.

There are not many places left where data about corporate bonds is still available. One of them is.morningstar.com/BondCenter”>http://finra-markets.morningstar.com/BondCenter. To find data for a particular company’s bonds, find the Quick Search feature, then be sure to specify corporate bonds and type in the name of the issuing company. This should give you a list of all of the company’s outstanding bond issues. Clicking on the symbol for a given bond issue will lead you to the current amount outstanding and the yield to maturity. You are interested in both. The total of all bonds outstanding is D in the above formula.

If you like, you can use the YTM on a bond issue that is not callable as the pre-tax cost of debt for the company.

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Deliverable

Write a two or three page report that contains the following elements:

1. Your calculated WACC.

2. How data was used to calculate WACC. This would be the formula and the formula with your values substituted.

3. Sources for your data.

4. A discussion of how much confidence you have in your answer. What were the limiting assumptions that you made, if any.

The following is the formula used to calculate the WACC for Kohl’s Corporation:

rWACC = (E/E+D) rE + D/(E+D) rD(1-TC). Per.yahoo.com/”>http://finance.yahoo.com, the ? (beta) is 1.70 and the E (market capitalization rate) is 9.19B.

Total bonds outstanding (D), per.morningstar.com/stocknet/bonds.aspx?symbol=kss”>http://quicktake.morningstar.com/stocknet/bonds.aspx?symbol=kss is $2.8 million.

For the cost of equity, I will be using the following formula: re = rf + ?(rm – rf) where rf= risk free rate, ? = Beta, rm = expected market return, and (rm – rf) = equity market return

The return of equity is

2.401. The equation is re = 2.29 + 1.14(11.71 – 1.14)

re = 2.29 + 1.14(10.57) = 2.29 + 12.05 =14.34%

In order to obtain the return of equity, the following formula must be used:

ROE then becomes:

Net income ÷ shareholders’ equity

The Cost of Equity formula used is re = rf + ?(rm – rf) where rf= risk free rate, ? = Beta,

rm = expected market return, and (rm – rf) = equity market return. The return of equity is

2.401. The equation is re = 2.29 + 1.14(11.71 – 1.14)

re = 2.29 + 1.14(10.57) = 2.29 + 12.05 =14.34%

In December, 2014, Kohl’s Corporation had outstanding multi-year bonds with an average yield to maturity of 3.975% and a BBB rating. If corresponding risk-free rates were 2.29%, and the market risk premium is 4%, the estimated expected return of Kohl’s Corporation debt is 2.69%. The equation is rd = rf + ?(rmkt)

rd =2.29% + 0.10(4%) = 2.69%

The formula for the required return on a given equity investment is ri= rf + ?i * (RMkt-rf). The equation is ri = 2.29 + 1.14(4.00 – 2.29)

ri = 2.29 + 1.14(1.71) = 2.29 + 1.95 = 4.24%

The Market Risk Premium formula was RMkt-rf, and for this project the Market Risk Premium was assumed to be 4%.

According to Marotta (2012), “The simplest equation for the markets would be “Return equals 11.71%.” This has been the average return from 1927 through 2010, the zero factor model. Put your money in the market, and you will get, on average, 11.71% annually.” Therefore, rm= 11.71%.

The risk free rate is rf and using the YTM on a 10 year US Treasury securities the approximation for the risk free rate is 2.29.

The corporate tax rate was assumed to be 40%.

References

Investor Relations – SEC Filings. (n.d.). Retrieved October 8, 2015, from http://www.kohlscorporation.com/InvestorRelations/sec-filings.htm

Quotes & Info- Yahoo! Finance. (n.d.). Retrieved October 8, 2015, from http://finance.yahoo.com/q;_ylc=X1MDMjE0MjQ3ODk0OARfcgMyBGZyA3VoM19maW5hbmNlX3dlYgRmcjIDc2EtZ3AEZ3ByaWQDBG5fZ3BzAzEwBG9yaWdpbgNmaW5hbmNlLnlhaG9vLmNvbQRwb3MDMQRwcXN0cgMEcXVlcnkDS1NTLARzYWMDMQRzYW8DMQ–?p=http://finance.yahoo.com/q?s=KSS&ql=