Question
c) Calculation, presentation and evaluation of the companys WACC d) A critical discussion of the issues you faced while calculating the WACC please review the
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c) Calculation, presentation and evaluation of the companys WACC
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d) A critical discussion of the issues you faced while calculating the WACC
please review the below answer and give me your feed back and comments
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Calculation confined to Weights: In the general perspective company's assets are financed by debt and equity and hence calculation of the weight of equity and the weight of debt plays an important roleThe market value of equity is also known as - Market Cap. As at the latest balance sheet, Just Eat's market capitalization is 18294.757 million. The market value of debt is typically difficult to calculate, therefore, I have used book value of debt to calculate. It is simplified by adding the latest two-year average and long-term debt & capital lease obligationparallel.
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As of June 2019, Just Eat's latest two-year average short-term debt & capital lease obligation was 0.457969932467 million and its latest two-year average Long-Term Debt & Capital Lease Obligation was 65.0111989683 million. Therefore the total book value of debt is 65.4691689008million.
Therefore the Calculation of Weight is as follows:
a) Weight of equity = E / (E + D) = 18294.757 / (18294.757 + 65.4691689008) = 0.9964 b) Weight of debt = D / (E + D) = 65.4691689008 / (18294.757} + 65.4691689008) = 0.0036
Calculation confined to Cost of Equity:
The Capital Asset Pricing Model (CAPM) is used to calculate the required rate of return. The formula is will be as follows: Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market - Risk-Free Rate of Return)
Points considered for calculation:
a) A ten years treasury constant maturity rate is extracted as the risk free rate; latest risk free rate is 0.82960000% (Economic Indicators ). b) Beta is the sensitivity of the expected excess asset returns to the expected excess market returns. Just Eat's beta currently is 1.14. c) The expected return of the market - risk-free rate of return) is also called market premium. requires market premium to be 6%.
Therefore the Cost of Equity
Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market - Risk-Free Rate of Return)
Cost of Equity = 0.82960000% + 1.14 * 6% = 7.6696%
Calculation confined to Cost of Debt: The data of last fiscal year end interest expense is divided by the latest two-year average debt that is arrived at simplified cost of debt. The calculation is as follows:
As of December 2018
Just Eat's Interest Expense
3.42 million
Total Book Value of Debt (D)
65.46 million
Cost of Debt = Interest Expense
Total Book Value of Debt
3.42 million
65.46 million
Therefore Cost of Debt
5.2245%
Interest Expense Explanation
Note: If the annual report is silent on details about interest expense and interest on income and the net interest income is negative then the net interest income will be used as interest expense. In the calculation shown below interest expense is calculated by the latest two-year average debt in order to arrive at the cost of debt (simplified).
Just Eat PLC has ingress to a GBP of nearly 350.0 million RCF (revolving credit facility), its operating income was 30 million, it is further noted that the long term debt and the capital lease obligation was 295 million.
Therefore Just Eat's Interest Coverage for the second quarter is calculated as follows:
Interest Coverage = - 1 * Operating Income / Interest Expense
Interest Coverage = - 1 * 30.0380228137 / -3.42205323194
Interest Coverage = 8.78
WACC
=
E
/
(E + D)
*
Cost of Equity
+
D
/
(E + D)
*
Cost of Debt
*
(1 - Tax Rate)
WACC =
0.9964
*
7.6696%
+
0.0036
*
5.9937%
*
(1 - -7.37%)
WACC = 7.67%
Issues Faced while calculating WACC:
- While calculating cost of debt is more simplistic, relative to calculating cost of equity, there are still problems that arise. To calculate cost of debt, we add a default premium to the risk-free rate. This default premium is the returnin excess of the risk free rate that a bond must yield. It will rise as the amount of debt increases (since, all other things being equal, the risk rises as the amount of debt rises).
- Problems concerning market values Watson and Head (2007) explain that some securities do not have market prices because they are not often traded, like ordinary shares of private firms. So it is difficult to include them in the cost of equity. One possible solution is to find company implied in the same business branch. At this moment, we can calculate cost of equity with its particular market price and add a premium to reflect higher risk of private firm. This calculation does not reflect real market value of an ordinary share but it permits to make estimation. Moreover, it is possible to find market value of a bond by taking another bond with equal maturity, with an equivalent risk and interest rate.
- To produce the most accurate result, we must take this risk-free rate from a bond containing a similar term structureto our company's debt. Risk-free rates are typically approximated from Treasury bills, notes, and bonds. Problems can arise because these are issued only in terms of two, three, five, ten and thirty years. These terms may not always adequately match the term of our company's debt.
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Generally, lenders price short term and long-term loans (revolving or amortized) differently. Therefore, considering both types of loans as identical priced is far from reality.
- The company has not paid dividend in recent past and any alteration in their dividend payment policy considered unlikely in foreseeable future as per the market information. Therefore, using dividend growth model to calculate cost of equity is not feasible.
- No clarity on borrowing rates related to revolving bank loans restricts our analysis,
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