Question
Details 1. Your report will have no extended textual part; i.e., no long paragraphs. 2. Your report should include supporting data, such as snipped p
Details
Picking Your Corporation
The Primary Equations
The theory of why managers should use the WACC in net present value analysis comes later in the course. For now, start with the equations for WACC, per se:
ka = (E/V)*ke + (B/V)*kd*(1 t)[1]
V = E + B
ka is the required rate of return on the firms assets, which is thesame as WACC.
ke is the firms marginal cost of common equity.
kd is the firms marginal cost of debt.
V is the total market value of the corporation. (not explicitly in the textbook)
E is the market value of outstanding common equity.
B is the market value of outstanding notes, debt, bonds, debentures, mortgages, and other interest-bearing securities.
t is the marginal tax rate the firm faces.
1. Estimate the Marginal Cost of Debt
Marginal Cost of Debt: This is an estimate of the interest rate the corporation would have to pay on new borrowing.
Method 1: Try to find the yield to maturity on your firms long-term debt. Try google and see what you find.
Method 2: Try to find your corporations Standard and Poors issuer debt rating. Again, try google. Then look on page 205 in your textbook at the table and estimate an appropriate rate. For example, if you find the rating is AA-, which would fall between AA and A, you may decide to choose 4.5% (which is between the 4.40 %and 4.62% in the 25-year section)
Method 3 (optional): If method 1 and 2 provide nothing, first double check to make sure your firm has long-term debt, and then follow steps 1 and 2 for a close competitor of your firm, and then make a judgment call on a estimate of Kd for your firm.
If the rating is junk [BB, B, and CCC], you have to creatively add a premium to the BBB interest rate.
Method 4: kd = rf + premium
In this method, add a premium to the risk-free rate (Rf). (See below for how to obtain Rf). You can use information from page 205 to guide you. For example, lets say you did not find your firms issuer credit rating, you can make an educated guess of what it would be, and then add an appropriate premium to Rf. For example, if you guess the credit rating should be an A, the difference in the 25-year row of page 205 is 1.81 percentage points (4.62% - 2.81% for the Treasury). Take the Rf rate and add 1.81% to it for your estimate of Kd.
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