I need help with this problem i have. The company I chose was apple because i fi
ID: 2768759 • Letter: I
Question
I need help with this problem i have. The company I chose was apple because i figured it would be the easiest. I know i listed the formulas, but i cant find any of the numbers. Can anyone possibly help? I need to know what numbers go in what formula.
Much appreciated.
Company Valuation
1. Analysis of WACC
a. Calculation of WACC for your company:
You will need to identify each component of the WACC formula and calculate the overall WACC.
The WACC formula for a company that uses debt and equity is as follows:
WACC = % Debt * Cost of Debt * (1 - Tax Rate) + % Equity * Cost of Equity
*You should use Yahoo! Finance and / or the company's most recent 10K report to identify all financial statement inputs. You can use the following guide for the inputs. The specific financial statement data are found on the relevant financial statement. Debt = Long-term Debt + Short-term Debt (on Yahoo! this is called, "Short/Current Long Term Debt")
Equity = Market Cap. (This is on the Key Statistics page in Yahoo! Finance)
% Debt = Debt / (Debt + Equity)
% Equity = 1 - % Debt
Cost of Debt = Interest Expense / Debt
Tax Rate = Income Tax Expense / Income Before Tax
Cost of Equity: Use the CAPM equation to calculate this
Cost of Equity = Risk free rate + Beta * (Market Risk Premium)
Risk free rate: look up the yield on 10 year US Treasury bonds
Beta: This is on the Key Statistics page in Yahoo! Finance
Market Risk Premium: Assume 11% minus the risk-free rate
b. Interpretation of WACC for Your Company
*Indicate what the WACC value you derived means for your company.
*What role does the WACC play for company managers when they are evaluating new projects to undertake?
*How would company managers and investors use the WACC for an overall company valuation analysis?
Explanation / Answer
Solution:
I have answered the above questions together:
WACC is the weighted average cost of capital which helps the management to decide whether to acceot the project or not and helps in investment decision , becasue the WACC could be consider the minimum rate of return a company would expect from a project and if the net present value is positive at the WACC then the project can be accepted.
The capital funding of a company is made up of two components: debt and equity. Lenders and equity holders each expect a certain return on the funds or capital they have provided. The cost of capital is the expected return to equity owners (or shareholders) and to debtholders, so WACC tells us the return that both stakeholders - equity owners and lenders - can expect. WACC, in other words, represents the investor's opportunity cost of taking on the risk of putting money into a company.
To understand WACC, think of a company as a bag of money. The money in the bag comes from two sources: debt and equity. Money from business operations is not a third source because, after paying for debt, any cash left over that is not returned to shareholders in the form of dividends is kept in the bag on behalf of shareholders. If debt holders require a 10% return on their investment and shareholders require a 20% return, then, on average, projects funded by the bag of money will have to return 15% to satisfy debt and equity holders. The 15% is the WACC.
If the only money the bag held was $50 from debtholders and $50 from shareholders, and the company invested $100 in a project, to meet expectations the project would have to return $5 a year to debtholders and $10 a year to shareholders. This would require a total return of $15 a year, or a 15% WACC
Any rational investor will invest time before investing money in any company. The investor will try to find out the valuation of the company. Based on the fundamentals, the investor will project the future cash flows and discount them using the WACC and divide the result by no. of equity share holders. He will get the per share value of the company. He can simply compare this value and the current market price (CMP) of the company and decide whether it is worth investment or not. If the valuations are more than the CMP, the scrip is under-priced and if it is less than CMP, it is overpriced. If the value is $25 and CMP is 22, the investor will invest at 22 expecting the prices to rise till 25 and vice versa.
Conclusion: WACC is an important metric used for various purposes but it has to be used very carefully. The weights of the capital components should be expressed in market value terms (Refer: Market Value vs. Book Value WACC). The market values should be determined carefully and accurately. Faulty calculations of WACC will result in faulty investment decisions as well. There are issues such as no consideration given to floatation cost which are not worth ignoring. The complications increase if the capital consists of callable, puttable or convertible instruments, warrants.