"Establishing the cost of equity is the most arbitrary and difficult part of developing a firm's cost of capital. Outline the reasons behind this problem and the approaches available to make the best of it"
Now, calculate an approximate WACC for one of your chosen companies in your previous week beta portfolio. Also, do the same for its nearest competitor.
- First, you will need to calculate your chosen companies capital weights. You can do this by calculating the percentage of each by the amounts shown on their respective balance sheets
- Assume that the before-tax cost of debt for the corporations is 5%.
- Again, obtain the beta of your company and its major competitor.
- Assume, that currently the risk-free rate is 2.0% and the market return is 8% . What is the expected return on equity of each of the two companies’ stocks ?
- Use the amounts (capital weights, return on debt and return on equity) calculated above in your WACC calculation
** (Since preferred stock constitutes very little of the capital structure, for this exercise, disregard preferred stock percentages).
What would your calculated WACC's imply for the firm’s capital budgeting projects ?