The
Weighted AVERAGE Cost of Capital (WACC)
The WACC is the basis
to judge a investment project.
WACC
using CAPM
WACC of
STARWORLD GROUP
Risk free rate : 0,317% ; Return
on the market 8,204% ; ßeta
of stock : 0,90 ;D/E ratio : 0,47; Interest rate
(Cost of debt) of the company : 2 % ; Tax
rate : 30 %
| |
End 2024 |
| Long
Terme Debt |
1050 |
Market Value of Equity |
2244 |
Total
(V) |
|
(CAPM)
Return on stock (Rs) = Rf + ß.(Rm
- Rf) |
Rs =- 0,317% +
0,90.(8,204 % -0,317 %) = 7,42 %
| WACC
= Rs(Ke) . E/V + Kd . D/V |
WACC =7,42 %
. (2'244 / 3'294) + (2 % - 30 %) . (1'050
/ 3'294) = 5,50 %
WACC
using growth
model
| Rs
=
|
EPS |
+
g
|
|
Price
of share |
| g
= ROE . Retention Rate of Dividend (RR) |
WACC of
STARWORLD
GROUP
Retention rate of
dividend (RR) : 20.29 %
Distribution rate of dividend : 79.71
%
ROE
= (DIV / Price of share = Dividend Yield) = 25.90 / 102,00
= 25.39 %
g
= ROE . RR = 25.39 % . 0,2029 % = 5,15
%
Rs
= ROE + g = 25.39 % + 5,15% = 30.54 %
(market capitalisation rate)
WACC
= 30,54 % . (2'244 / 3'294 ) + (2 % - 30
%) . (1'050 / 3'294) = 21.25 %
The WACC rule
Many companies estimate the rate
of return required by investors in their securities
and use the company WACC to discount the Free
Cash Flows on all new projects.
But the company WACC rule can also get the firm
into trouble if the new projects are more or
less risky than its existing business. Each
project should be evaluated at its own Opportunity
Cost of Capital (OCC). The true OCC
depends on the use of capital.
If a firm uses the company cost
of capital rule, it would reject many good low-risk
projects and accept many poor high-risk projects.
CAPM
model is widely used by large corporations to
estimate the discount rate.
To calculate this formula, we
have to estimate the project beta. This can
be achieved by looking at an average of similar
companies.
Cost of capital
and capital structure
The Cost of capital is the norm
to be respected for capital budgeting decisions.
It depends on the business risk of the firm's
investment opportunities. The risk of a common
stock reflects the business risk of the real
assets held by the firm. But shareholders also
bear financial risk to the extent that the firm
issues debt to finance its real investments.
The more a firm relies on debt financing, the
riskier its common stock is.
Conclusions
If
ROA > WACC :
Sources :
Principles of Corporate Finance,
8th edition, Richard A. Brealey & Stewart
C. Myers, McGraw-Hill
© ECOFINE.COM, Bernard Jaquier, Professor in Economics and Finance, Switzerland 2025
