Use cost of equity and the cost of debt calculated to estimate the weighted average cost of equity. The weights for equity and debt can be estimated by using the current market value of equity and the book value of long-term and short-term debt (Company Home Depot) Cost of Equity: 10.625% Cost of debt: 0.0373002

Full Question as asked for

2.3 Weighted Average Cost of Capital (WACC)

Use one measure of the cost of equity and one measure of the cost of debt calculated in sections 2.1 and 2.2 to estimate the weighted average cost of equity. The weights for equity and debt can be estimated by using the current market value of equity and the book value of long-term and short-term debt.

2.1 Cost of Debt

You are required to estimate the cost of debt using at least one of the three possible measures. You are expected (in good faith) to estimate all three measures if data are available.

• Use the yield on companys long-term bond outstanding as the pre-tax cost of debt. Use a long-term straight bond with no convertible features for this purpose. (Source: Bloomberg fixed income). Refer to appropriate slides in the lecture notes.
• Estimate cost of debt from financials (gross interest expense from income statement divided by long-term + short-term debt outstanding from balance sheet).
• Use the cost of debt associated with the firms current credit rating (i.e., default spread associated with the rating plus 10-year treasury rate. Most recent default spreads are available on Prof. Aswath Damodarans website

2.2 Cost of Equity:

You are required to estimate the cost of equity using capital asset pricing model (CAPM). In order to do this, you need estimates of risk-free rate, market equity premium and stock beta.

2.2.1 Risk-free Rate:

Choose an appropriate risk-free rate (for ex. 10-year T-Bond rate). Refer to the appropriate slides in the lecture notes and class discussion on choosing the correct risk-free rate. Sources: any finance website such as yahoo, wsj or google finance.

2.2.2 Market Equity Premium

You are required to estimate two measures of market equity premium.

Historical premium calculated as average market premium for the last 10 years.

• Implied equity premium needs to be calculated using the following data:
  • Price value of S&P500 index as of January 2, 2020
  • Dividend and buyback yield on S&P 500 firms. This data is available on S&P website. S&P releases this information once every three months. (www.spindices.com index news and announcements search for dividend and buybacks). You may choose to use the yield for 2020 or an average for the last five years.
  • S&P 500 growth forecast for the next five years (yahoo finance. Enter your company ticker; go to analyst forecasts and look for earnings growth forecast for the next five years. Your companys growth forecast and S&P 500 growth forecast are available)
  • Estimate of long-term growth rate you may use the 10 year treasury rate on January 2 2020
  • Once you collected this data, use the excel sheet provided by me to estimate implied premium.

2.2.3 Stock Beta

You are required to estimate two measures of your companys stock beta

• Run a regression using Excel. Download adjusted close price data for S&P 500 and your company from yahoo finance. Using these prices, calculate returns and run a regression using Excel. Please use monthly prices for from January 01 2014 to December 31 2019
• The second measure is getting a beta from Bloomberg using S&P as the market index. (Type beta in Bloomberg and you will see a screen where you can select the company, frequency, time period etc). Click enter and you will see a beta estimate. Use the same frequency and time period as you did for excel regression