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ZZ Weighted average cost of capitalFIn this spreadsheet we will calculate weighted average cost of capitalWe will not stop on detailed explanations and economic meanings of the variables, because there is too much info on that in the webfWe will focus on the main steps of WACC calculation and different approaches applicable to each stepsYou should know that there is no unique approach to WACC calculation and many analysts create their own approaches and logic for WACC modelWACC,Traditional formula for WACC calculation is:,WACC = We x Ce + Wp x Cp + Wd x Cd x (1  t)orDLet's calculate separately each of the elements in the formula abovey = Market value of common stock / (Market value of common stock + Market value of preferred stock + Market value of debt)This is one of the most important elements of WACC formula and one of the most difficult for calculation. We'll return to this formula later in "Cost of equity" part = Market value of preferred stock / (Market value of common stock + Market value of preferred stock + Market value of debt)r = Market value of debt / (Market value of common stock + Market value of preferred stock + Market value of debt) but you now that the company has a debt, use the yields of bonds for similar companies' bonds (they should have same size, credit ratings, operate in the same industry, i.e. ,they should be similar in all possible ways)NLet's also look at the formulas for some of the elements in the formulas aboveeMarket value of common stocks (MVc) = number of common stocks x current market price of common stocksnMarket value of preferred stocks (MVp) = number of preferred stocks x current market price of preferred stocksMarket value of debt (MVd) = Market value of the issued bonds; if the company has no bonds, but have bank loans, use their balance value for calculation; if the companybhas mixed debt structure, use debt value from its balance sheet (Longterm debt + Shortterm debt)<if the company has no debt than the Market value of debt = 0COST OF EQUITY9Cost of equity is one of the key elements of WACC formula6The classic formula for Cost of equity calculation is 2Let s calculate all the elements from this formulaSome analysts use current 10Y rates (for US 10Y notes it is about 2.9% now, in Dec 2010), some prefer average historical values, some use forecast for 10Y notes yieldsWhen analysts calculate cash flows not in $ or , but in some local currency, many of them use local government's 10 years bonds yield nominated in local currencyIf there is no such longterm debts available, you can use the rate for borrowings of the most reliable and safest company in the country nominated in local currencyMany economists still argue on the definition of the risk free rate, because some Emerging Markets countries defaulted on their debts in the past (for example Russia, Argentina). rThus we can not consider the yields of their bonds as a risk free rate in a classic /traditional interpretation. tAnyway, you can choose the approach which is more suitable for you and which you consider logical for your situationQMore on calculation of the risk free rate you can find on Aswath Damodaran's page@http://pages.stern.nyu.edu/~adamodar/pdfiles/papers/riskfree.pdfB (Beta) calculationHBeta describes the relation of returns between the stock and the market.The formula for Beta isBeta = Cov (Rs; Rm) / Var (Rm) BCov (Rs; Rm) is the covariance of the stock's and market's returnsYou can calculate covariance using COVAR function in excel (if you are interested you can also look at the definition of covariance in excel),Var (Rm) is the dispersion of market returns1You can calculate Var using VAR function in excelLet s explain this step by stepFirst download the daily values of the market index and the stock prices in two columns. Download the data for 1,2,3 or more yearsBAfter that calculate daily returns for the index and for the stock>After that use COVAR and VAR excel functions to calculate BetaFThe example of calculations in details you will find in "example" fileRm (Market return)ZMarket return is usually calculated as an average historical return of the country's indexFUsually analysts use 30 years history& or 50& That is for you to decide ;For US stock market I see Rm between 4% and 5.5% more oftenDSome stock exchanges on Emerging Markets have a very short history. In this case you can simply add Country Risk Premium to the historical return of a mature market (well it's actually US stock market)vMore on calculation of the county risk premiums, as well as particular rates, you can find on Aswath Damodaran's page:Ihttp://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html(For example, let's calculate Rm for CubaWe have 5% market return in US and 11.25% country risk premium for Cuba (see the link above), so Rm for Cuba = 5% + 11.25% = 16.25%/Now we can calculate the basic cost of equity. iSome analysts find this calculation not sufficient and add different premiums to the basic cost of equityFFor example, one of the most widely used premiums is liquidity premiumhAnalysts add 0.53% liquidity premium to incorporate the risk of inability to sell the stock immediatelyiYou can add premiums for poor transparency, weak corporate governance, risk of shareholders conflict etc Although some certain mathematical approaches to calculation of these premiums exist, many analysts often simply use their judgmentsCOST OF DEBTWhen you determine the cost of debt for the company you simply try to find at which rate the company is able to borrow moneyuIf the company has publicly traded bonds, your task is very easy  just use the yield of this bond as a cost of debtNote: cost of debt (rate) should be calculated for the debt nominated in the same currency as your DCFmodel (Discount Cash Flows model)MIf you calculate your DCFmodel in dollars, use dollar nominated bonds' yieldIf the company has no traded debt  try to find similar company with publicly traded debt. You are lucky if you find a company of a similar size with the same Drating as yours. Use this company's debt yield as your cost of debtYIf it has no rating, continue searching for a similar company with publicly traded bonds.kThe company should be similar in the structure of the capital, in size, it should be from the same industryIf the company has a debt in form of a bank loan, try to find the info on the rates on this loan in company's reports (financial statements, MD&A, SEC fillings)\The bank loan is usually more expensive than bonds so you can make an adjustment if you wantIf the company does not disclose the info on its rates, search this info on banks web sites, maybe ask your friends who work in bank about the possible loan rate for your company]In the separate excel files you can find examples of WACC calculation for different companies&EXAMPLE 1. For US incorporated company$We calculate WACC for ConocoPhillips*EXAMPLE 2. For nonUS incorporated company)We calculate WACC for Brazilian PetrobrasWACC = Weight of equity x Cost of equity + Weight of preferred stock x Cost of preferred stock + Weight of debt x Cost of debt x ( 1  tax rate)2We (Weight of equity) = MVc / (MVc + MVp + MVd) = Ce (Cost of Equity) = Rf + B x (Rm  Rf) = Risk free rate + Beta x (Market return  Risk free rate) = Risk free rate + Beta x Equity risk premium;Wp (Weight of preferred stock) = MVp / (MVc + MVp + MVd) =vCp (Cost of preferred stocks) = Div / Price = Annual dividend on preferred stock / Market price of the preferred stock/Wd (Weight of debt) = MVd/ (MVc + MVp + MVd) = Cd (Cost of debt) = the yield of company s <bonds; if the company has no bonds use the rate for company s bank loan; if you have no information on yields or rateszt (tax rate) = the rate of corporate income tax in the country where it is registered (where it pays corporate income tax)Ce (Cost of Equity) = Rf + B x (Rm  Rf) = Risk free rate + Beta x (Market return  Risk free rate) = Risk free rate + Beta x Equity risk premium(Rf (Risk free rate) is usually a yield for government's 10 year bonds. In USA the yield of Treasury notes is usually used while for European countries you can use 10 years German bondsbZJ #d'A
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