What is the weighted average cost of capital (WACC) and Why is it different from the rate of return to investors?
Explain with examples.
To sustain a company finance is acts like a blood to pump up it's operations and that finance should be carrying a good proportion of weights in debt, equity and preferred stock on an average. This average is a weighted average cost of capital and gives us the percentage of that every dollar a company raises from investors must pay back average cost of capital percentage.
Now WACC is useful in calculating Capital asset pricing model, and this is calculated by multiplying with the equity, debt and preferred stock if any.
Let's consider an example... A firm believes that it needs to raise debt by the debt return of 6% and buys 400 bonds with for 200$ each. That makes debt of $80000 ( $200 X 400). It already has equity holdings of around 60000$, cost of equity is 0.4 and tax rate is 30%. To arrive market value, below is the method:
WACC = ($60000/($60000+$80000)) X 0.4 + [($80000/($60000+$80000)) X 0.6]X(1-0.30)] = 0.41 or 41%.
Rate of return is determined by Internal rate of return which decides the attractiveness of a project out of two.If the proposed WACC is supposed to be 10%, and the project gives an yield of 5%, the project is considered to be a fail. And one wouldn't want to pay higher rate when the actual rate is lower than the higher, that is the reason why rate of return is different from WACC from the perspective of Investors.
What is the weighted average cost of capital (WACC) and Why is it different from the...
1.What is (WACC), why is it used? 2. Why the weighted average cost of capital (WACC) is used in capital budgeting? 3. Estimating the costs of different capital components—debt, preferred stock, retained earnings, and common stock? 4. How to combine the different component costs to determine the firm’s WACC? 5. Cost of Equity: CAPM, what is it used for?
1. The weighted average cost of capital (WACC) is calculated as the weighted average of cost of component capital, including debt, preferred stock and common equity. In general, debt is less expensive than equity because it is less risky to the investors. Some managers may intend to increase the usage of debt, therefore increase the weight on debt (Wd). Do you think by increasing the weight on debt (Wj) will reduce the WACC infinitely? What are the benefits and costs...
The instructor said reasons why a company’s Weighted Average Cost of Capital (“WACC”) is critically important include:______. a. the WACC is the minimum rate of return to be earned on Common Stock. b. the WACC is the rate of return which must be earned by the Common and Preferred Stockholders. c. the WACC is the minimum rate of Free Cash Flow return to be earned on Total Assets. d. the WACC is the maximum amount of financial costs a company...
The instructor said reasons why a company's Weighted Average Cost of Capital ("WACC) is critically important include: (Select all the answers that apply.) the WACC is the rate of return which must be earned by the Common and Preferred Stockholders' Equity. the WACC is the minimum rate of return to be earned on Common Stockholders'Equity. the WACC is the minimum rate of Free Cash Flow return to be earned on total assets or proposed projects. the WACC helps management to...
Financial Options and Weighted Average Cost of Capital (WACC). Determine two to three methods of using stock and options to create a risk free hedge portfolio can be created. Support your answer with examples of these methods being used to create a risk-free hedge portfolio. Create a unique hypothetical weighted average cost of Capital WACC and rate return. Recommend whether or not the company should expand, and defend your position.
(1) A firm's weighted average cost of capital (WACC) is sometimes referred to as the hurdle rate. What is the purpose of calculating the firm's WACC? Why is the WACC referred to as the hurdle rate? (2) Based on your opinion, which component cost (cost of debt, cost of preferred stock, cost of retained earnings, or cost of new common stock) is easier to calculate? Which component cost is more difficult to calculate? Why?
Weighted Average Cost of Capital (WACC) Apple Inc. has 5,366,166,000 shares traded at a market value of $126 per share; its debt outstanding has an estimated market value of $90,883,140,000. The stock has a beta of 1.193. The expected return on stocks is 8.78%. The firm is rated AAA and paid 30% of its income as taxes. The risk-free rate is 2.47%, and the yield-to-maturity of Apple’s bonds is 3.27%. A. What is Apple’s debt ratio? B. What is Apple’s...
Based upon the following facts calculate the Weighted Average Cost of Capital (WACC) for Student Success Corporation (SSC): PART 1 WACC Tax rate 40 % Debt Financing: $10,000 Face Value 10-Year, 5 % Coupon, Semiannual Non-Callable Bonds Selling for $11,040 New bonds will be privately placed with no flotation cost. >Common Stock: Current Price $40; Current Dividend $3.00 and Growth Rate 5 %. >Common Stock: Beta 1.1; Risk Free Rate 2.0 %; Required Return of the Market 7% Capital structure:...
Apply weighted average cost of capital (WACC) into a real company. Choose a company and compute its WACC. Use the historical risk-free rate of 3.4% and the market return of 12.1%. please show work.
What does WACC stand for? A. Weighted Average Cost of Collecting B. Weighted Average Cost of Closing C. Weighted Average Cost of Capital D. None of the Above