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)
US Treasury Bonds Rates
Maturity
Yield
Yesterday
Last Week
Last Month
3 Month
0.03
0.04
0.04
0.06
6 Month
0.08
0.08
0.09
0.09
2 Year
0.23
0.23
0.23
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.


Ratings
Rating Date
Credit Watch/
Outlook
Credit Watch/
Outlook Date
Issuer Credit Rating
Foreign Long Term
AA
25-Jul-1983
--/Stable
09-Jul-1999
Foreign Short Term
A-1+
22-Jul-1983
Local Long Term
AA
25-Jul-1983
--/Stable
09-Jul-1999
Local Short Term
A-1+
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
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
20yr AAA
3.44
3.46
3.46
3.42
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


Average YTM
8.824%




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.
Reuters: http://www.reuters.com/finance/stocks
MSN: http://moneycentral.msn.com/home.asp

Beta





MSN Money
Reuters
Average

WMT
0.34
0.34
0.34


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: http://moneycentral.msn.com/home.asp


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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