Illustrations of WACC Calculation Examples using Walmart
Capital Structure
Before the new
project can be evaluated, the weighted average cost of capital (WACC), weight
of debt, weight of preferred stock, and weight of common stock need to be
determined for Wal-Mart.
The value of
common stock is calculated by multiplying the number of shares at the end of
the fiscal year by the price per share at the end of the fiscal year. The number of shares is found in the income
statement and the price per share is available on yahoo.com/finance. The book value of debt is available in the
balance sheet as explained by our financial management homework help experts. The annual statement
makes no reference to preferred stock.
The weight of common stock, preferred stock, and debt is calculated by
dividing each by the summation of all values, respectively.
Weighted Average Cost of Capital (WACC)
The cost of
debt, preferred stock, and common stock are needed to calculate the weighted average
cost of capital (WACC) for Wal-Mart. If
the annual statement makes no reference to preferred stock then the cost of
preferred stock is not calculated.
Estimate
the Cost of Debt (Rd)
A horizon of 10
years is typically assumed for cost of capital calculations. The most direct
method to estimate Rd is to find the Yield to maturity (YTM) for 10 years bonds
of the company. However, it is often difficult to find such bonds for the
company that we are studying. Therefore, we use information from the bond
markets to estimate the cost of debt for companies with public debt. We make
use of the following formula:
Nominal
or quoted market interest rate on bonds = Rd = Rrf + DRP + LP
where Rrf is the
risk-free rate, DRP is the default risk premium, and LP is inflation premium. Since
LP is very low for Treasury securities and for securities issued by large
corporation, we assume that LP = zero. Thus, Rd = Rrf + DRP
Ø
Estimating the Risk-Free Rate
A survey of
highly regarded companies shows that about two-third of the companies use the
rate of return on long-run Treasury bonds. We will use the 10-year T-bond as a
proxy for the risk-free rate as per our accounting homework help canada experts.
Main Source
finance.yahoo.com/bonds (http://finance.yahoo.com/bonds)
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US Treasury Bonds Rates
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||||
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Maturity
|
Yield
|
Yesterday
|
Last Week
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Last Month
|
|
3 Month
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0.03
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0.04
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0.04
|
0.06
|
|
6 Month
|
0.08
|
0.08
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0.09
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0.09
|
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2 Year
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0.23
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0.23
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0.23
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0.23
|
|
3 Year
|
0.33
|
0.34
|
0.35
|
0.34
|
|
5 Year
|
0.74
|
0.77
|
0.73
|
0.76
|
|
10
Year
|
1.83
|
1.86
|
1.84
|
1.87
|
|
30 Year
|
3.08
|
3.12
|
3.10
|
|
So the Risk-free rate is 1.83%. Please make sure to update the Risk-free rate from the
finance.yahoo.com/bonds (http://finance.yahoo.com/bonds)
Ø
Estimating the Default Risk Premium
The default risk
premium is zero on Treasury securities, but it can be substantial for corporate
bonds. Since the 1900s, bonds have been assigned quality ratings that reflect
their probability of going into default.
Source: http://www2.standardandpoors.com.
This is a free source of information but you need to register first. Then, you
select rating, and then select rating search and you enter the name of your
company.
Wal-Mart Stores
Inc.
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||||
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Issuer Credit Rating
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||||
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Foreign Long Term
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AA
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25-Jul-1983
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--/Stable
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09-Jul-1999
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Foreign Short Term
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A-1+
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22-Jul-1983
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||
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Local Long Term
|
AA
|
25-Jul-1983
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--/Stable
|
09-Jul-1999
|
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Local Short Term
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A-1+
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22-Jul-1983
|
||
WMT has an AA
rating (Local Long Term Credit Rating). Once we have the rating of the company,
we need to estimate DRP or get the average yield of companies with the same
rating.
Ø
Method 1:
If the company has a rating of A, AA or AAA, then we can use the yield
based on the following table from: (http://finance.yahoo.com/bonds/composite_bond_rates)
|
Corporate Bonds
|
||||
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Maturity
|
Yield
|
Yesterday
|
Last
Week
|
Last
Month
|
|
2yr AA
|
0.49
|
0.49
|
0.50
|
0.44
|
|
2yr A
|
0.71
|
0.71
|
0.74
|
0.72
|
|
5yr AAA
|
0.94
|
1.00
|
1.00
|
0.84
|
|
5yr AA
|
1.29
|
1.33
|
1.25
|
1.25
|
|
5yr A
|
1.58
|
1.61
|
1.60
|
1.58
|
|
10yr
AAA
|
2.39
|
2.43
|
2.47
|
2.42
|
|
10yr
AA
|
2.80
|
2.84
|
2.87
|
2.81
|
|
10yr A
|
2.95
|
2.99
|
3.03
|
2.98
|
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20yr
AAA
|
3.44
|
3.46
|
3.46
|
3.42
|
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20yr AA
|
4.03
|
4.03
|
4.00
|
4.01
|
|
20yr A
|
4.23
|
4.25
|
4.27
|
4.16
|
Please be
advised the above table is based on previous numbers and need to be updated
from (http://finance.yahoo.com/bonds/composite_bond_rates).
The 10yr AA yield could be used for WMT because it matches
the rating. However, most of the companies won't be AAA, AA or A so we need to
search for a sample of companies with similar ratings. Therefore, the
default risk premium (DRP) = 2.80%.
Ø
Method 2: Use Yahoo!finance Bond center
to search for bonds with 10yr maturity matching the Ratings of the company we
are studying (http://screen.yahoo.com/bonds.html).
This method will be used if the rating of your company is BBB, B+, B.
|
B Rating
|
|
|
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Average YTM
|
8.824%
|
|
|
|
|
|
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BBB Rating
|
|
|
|
Average YTM
|
4.83%
|
|
According
to the above calculations, the before tax cost of debt (Rd) = Rrf + DRP = 1.83%
+2.80% = 4.63%.
Estimating
the Cost of Equity (Rs)
The cost of
common stock (equity) is determined using an average of the CAPM approach, DCF
approach, and the bond-yield-plus-risk premium.
Ø
CAPM approach
The cost of
equity (Rs) using CAPM is determined using the formula Rs = Rrf
+ (MRP *β). Rrf is determined
using the 10 year Treasury bond which is currently 1.83%. The market risk premium (MRP) equals the average expected
return from the market (10.3 percent) minus the risk free rate (1.83 percent). The market risk premium = 8.47 percent.
Note:
The S&P has returned an average of 10.3 percent a year, compounded, since
1926 (CNN, 2008). All students should use 10.3% as the average expected
return from the market regardless of their selected companies.
The beta value (β)
is calculated by averaging the beta values from msnmoney.com, and reuters.com.
|
Beta
|
|
|
|
|
|
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MSN Money
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Reuters
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Average
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WMT
|
0.34
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0.34
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0.34
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||
Accordingly, the cost of equity (Rs) using
CAPM = 1.83% + 0.34 (8.47%) = 4.7098%. Please be advised the above table is based on previous numbers and need
to be updated.
Ø
DCF
approach
The second estimate for
Rs is calculated using the DCF approach. To determine a dividend yield, we use msnmoney.com.
Please be advised the above table is based on previous numbers and
need to be updated.
Rs = Dividend yield + Expected
Growth.
|
|
|
MSN Money
|
|
WMT
|
|
2.40%
|
The expected
growth can be calculated using the long-term growth rate for EPS. The long-term
growth rate is an average from two sources: yahoo.com, and msnmoney.com.
v
MSN: http://moneycentral.msn.com/home.asp then select Earnings Estimates, and then
Earnings Growth Rates (use Earnings Growth Rates for the next 5 years).
|
Earnings
Growth Rates
|
Last
5 Years
|
FY
2011
|
FY
2012
|
Next
5 Years
|
11
P/E
|
|
Company
|
+9.60%
|
+6.30%
|
+10.30%
|
+9.40%
|
14.70
|
|
Industry
|
+3.90%
|
+8.70%
|
+8.90%
|
+9.90%
|
16.00
|
|
S&P
500
|
+3.20%
|
+5.80%
|
+5.70%
|
NA
|
15.20
|
Please be
advised the above table is based on previous numbers and need to be updated.
v Yahoo:
http://finance.yahoo.com/ then select Analyst Estimates, then look at
the Growth Estimation Table (use next 5 year).
|
Growth Est
|
WMT
|
Industry
|
Sector
|
S&P 500
|
|
Current Qtr.
|
5.50%
|
20.90%
|
-17.40%
|
10.40%
|
|
Next Qtr.
|
9.30%
|
57.60%
|
-1.50%
|
16.20%
|
|
This Year
|
6.60%
|
12.80%
|
23.10%
|
8.20%
|
|
Next Year
|
9.90%
|
21.50%
|
-12.00%
|
12.90%
|
|
Past 5 Years (per annum)
|
9.64%
|
N/A
|
N/A
|
N/A
|
|
Next 5 Years (per annum)
|
9.04%
|
12.07%
|
14.15%
|
8.98%
|
|
Price/Earnings (avg. for
comparison categories)
|
14.60
|
18.29
|
20.19
|
18.97
|
|
PEG Ratio (avg. for comparison
categories)
|
1.62
|
1.40
|
1.87
|
1.94
|
Please be
advised the above table is based on previous numbers and need to be updated
from (http://finance.yahoo.com/).
|
|
Yahoo
|
MSN Money
|
Average
|
|
WMT
|
9.04%
|
9.40%
|
9.22%
|
Accordingly, the cost of equity (Rs) using the DCF Approach = Dividend
yield + Expected Growth (2.40% + 9.22% = 11.62%)
Ø Bond
Yield plus Risk Premium Approach
The last
estimate for Rs is calculated using the bond yield plus risk premium approach,
Rs =
Rd + RP. The risk premium is
between 5% and 7%. Let assume that RP is given at 5% for all companies. All
students should use 5% risk premium regardless of their selected companies.
Rd was determined previously to be 4.63% for a firm with a AA rating as explained by accounting homework help experts.
Therefore, Rs = 4.63% + 5% = 9.63%. Before
calculating the WACC, we determine the appropriate Rs by averaging the three
approaches used to estimate Rs.
|
|
CAPM
|
DCF
|
Rd + DRP
|
Average
|
|
WMT
|
4.7098%
|
11.62%
|
9.63%
|
8.6533%
|
Estimating Weights (Ws)
Use market value
for equity and book value for bonds & preferred stock. To estimate the
weight of common equity we calculate Market capitalization (Year-end shares
outstanding x price at the end of fiscal year). The number of outstanding
shares can be found from the reported income statement for your selected
company. The price of common stock at the end of fiscal year can be obtained
from yahoo.com.
Yahoo: http://finance.yahoo.com/ then select Historical Prices and you select
the close price. As of December 31, 2012, the close price for Wal-Mart is $68.23.
Results
The WACC of 7.78%
is illustrated by gathering the previous calculated values for the weight of
debt, cost of debt, weight of preferred stock, cost of preferred stock, weight
of common stock, and cost of common stock.
The
WACC formula: WACC = Ws*Rs + Wd*Rd*(1-Tax Rate) + Wp*Rp.
|
|
WMT
|
|
Ws
|
84.11%
|
|
Wd
|
15.89%
|
|
Wp
|
0.00%
|
|
Rd
|
4.63%
|
|
Tax rate
|
32.37%
|
|
Rs
|
8.65%
|
|
Rp
|
0.00%
|
|
WACC
|
7.78%
|
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