Weighted Average Cost of Capital (WACC) Analysis for Automotive Holding Group Limited

This presentation analyzes the weighted average cost of capital (WACC) for Automotive Holding Group Limited. It discusses the components of cost of capital and the computation method for WACC. The presentation also highlights the significance of WACC in assessing a firm's potential.

Business financial systems
Name of the student
Name of the university
Student ID

Introduction
The presentation will analyse the component
of weighted average cost of capital (WACC)
and the computation method of the same in
detail. The presentation will further analyse
the present WACC of the entity Automotive
Holding Group Limited. Automotive Holding
Group Limited is the diversified automotive
logistics and retailing group along with the
operations in each mainland state of New
Zealand and Australia.

Discussion
As most of the firms are highly
dependent on borrowed fund for their
business operation cost of the capital
becomes crucial parameter while
assessing the potential of the firm
regarding net profitability. Investors
as well as analysts use WACC to
analyse the return on investment.
WACC is computation of the capital
cost for the firm under which each of
the capital category is weighted on
proportionate basis.

Formula used for computing the WACC is –
WACC = E/V * Re + D/V * Rd * (1 – Tc)
It is computed through multiplying the cost of
each capital component by the proportional
weight. After that the sum of the result is
considered and is multiplied by (1 – corporate
rate of tax).

Components of cost of capital
It is the maximum rate of return that
the entity must earn from the
investment so that market value of the
market value of the entity’s equity
does not drop. This arrangement is
done with overall objective of the firm
with regard to maximization of wealthy.

3 major components of cost of capital are –
Cost of debt
Debt can be issued at premium, at par or at
the discount and can be redeemable or
perpetual. Method of computing cost of each
type of debt is –
Debt issued at par – computation approach for
this type of debt is an easy task compared to
other approach. It is explicit rate of interest
adjusted for entity’s tax liability. It is computed
as –
Kd = (I – T)*R

Debt issued at discount or premium –
when the debentures are issued ad
discount or at premium, cost of the
debt shall be computed on based on
the net proceeds received from
issuance of such bonds or
debentures. Such cost shall be further
adjusted taking into consideration the
applicable tax rate for the entity. Cost
of debt shall be computed as per the
below formula –
Kd = I * (1 – T) / NP

Cost of preference capital –
Calculation for cost of preference capital poses
few conceptual issues. For the borrowings,
legal obligation is there on the firm for paying
the interest at the fixed rate while for the
preference share no such obligation is there.
Therefore, some of the people argue that the
payable dividends on the preference share
capital shall not be treated as cost component.

Accumulation of the arrears for
preference dividend may have adverse
impact on the right of the equity
shareholders to receive the dividends.
The reason behind that is dividend
cannot be paid to the shareholders unless
the entity clears the arrears for
preference dividend. Owing to the same
the cost of preference capital is
calculated taking the same basis of
dividend.

Cost of equity capital –
Computation for cost of equity capital is difficult
one. Conceptually it is defined as minimum rate
of return that the firm shall earn on the part of
investment that is financed by equity.
Dividend price (D/P) approach
This approach emphasizes the dividend’s
importance however, it does not take into
account the fact that the retained earnings also
have an impact on the equity share’s market
price.
Cast of the new equity under this approach can
be computed as –
Ke = D/Np

Dividend price plus growth [(D/P) +
g] approach
As per this approach cost of the
equity capital is determined based
on the expected rate of dividend plus
growth rate of dividend. Rate of
growth for dividend is computed
based on the dividend amount paid
by the entity for past few years.
Computation for cost of capital as
per this approach can be done
through using the below mentioned
formula –
Ke = (D/Np) + g

WACC for Automotive Holding Group Limited
Beta of the company is 1.35
Risk free rate = Rf = 1.86%,
Market risk premium = Rm = 8.11%
Therefore, required rate of return or cost of equity of the
company =
R = Rf + β ( Rm – Rf )
R = 1.86% + 1.35* (8.11% - 1.86%) = 10.30%
The WACC is computed as follows –
WACC = E/V * Re +D/V * Rd * (1-Tc)
WACC = 0.33 * 10.30% + 0.67 * 2.10% * (1-0.30)
=4.38%

Conclusion
From the above analysis it can be concluded
that WACC reflects the expenses incurred by
the entity for raising one dollar of additional
money. From above it can be identified that
the WACC of Automotive Holding Group
Limited is 4.38% that indicates the entity
shall pay its investors an average of $
0.0438 in return for each additional funding
of $ 1.

Reference list