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Posted: February 21st, 2023
Essay on Weighted Average Cost of Capital
WACC: Weighted average cost of capital =WACC= SS+B? Rs+BS+B? RB? 1-tC note: Rs , cost of equity; RB , cost of debt; tC , corporate tax rate. For cost of equity, Rs, we calculate it by using the SML, according to CAPM model. Rs=RF+?? [RM-RF] As we can see in the chart behind the case, beta of Worldwide Paper Company is 1. 10; the Market risk premium (RM-RF) is 6. 0%. Because this on-site longwood woodyard project has six year life and the investment spend over two years, the total long of this program is more closer to 10-years, we choose the 10-year government bonds as risk free rate, 4. 60%.
Thus, Rs=4. 60%+1. 10? 6. 0% =11. 20%. For the cost of debt, there are two kinds of debts of Worldwide Paper Company, bank loan and long-term debt. The cost of long-term debt is 5. 78% (A rating 10-years maturities corporate bonds) , and the value of long term debt is $2500M. Thus, RB=5. 78%. For the value of equity and debt, market value weights are more appropriate than book value weights, because the market values of the securities are closer to the actual dollars that would be received from their sale. There are the market weights expected to prevail over the life of the firm or the project.
S=500? $24. 00=$12,000M; B=$2500 RWACC=1200012000+3000? 11. 20%+300012000+3000? 5. 88%=9. 76% Payback Period: YEAR| 2007| 2008| 2009| 2010| 2011| 2012| 2013| Total CF of investment| -16| -2. 4| -0. 6| | | | 2. 08| OCF| | 2. 88| 4. 5| 4. 5| 4. 5| 4. 5| 4. 5| Cumulative CF| -16| -15. 52| -11. 62| -7. 12| -2. 62| 1. 88| 8. 46| Thus, the payback period is 4+2. 624. 5=4. 58 year. Discounted Payback Period: YEAR| 2007| 2008| 2009| 2010| 2011| 2012| 2013| Total CF of investment| -16| -2. 4| -0. 6| 0| 0| 0| 2. 08| discounted CF of investment| -16| -2. 18| -0. 0| 0| 0| 0| 1. 18| OCF| | 2. 88| 4. 5| 4. 5| 4. 5| 4. 5| 4. 5| discounted OCF| | 2. 62| 3. 73| 3. 39| 3. 09| 2. 81| 2. 56| sum| -16| 0. 44| 3. 23| 3. 39| 3. 09| 2. 81| 3. 74| Cumulative CF| -16| -15. 56| -12. 33| -8. 94| -5. 85| -3. 04| 0. 70| Thus, the discounted payback period is 5+3. 044. 5=5. 81 year. Average Accounting Method: YEAR| 2007| 2008| 2009| 2010| 2011| 2012| 2013| average| net income| | -0. 12| 1. 5| 1. 5| 1. 5| 1. 5| 1. 5| 1. 23| investment| 16| 15. 4| 13| 10| 7| 4| 0| 9. 34| Thus, AAR=Average net incomeAverage investment=1. 239. 34=13. 16%
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