Weighted Average Cost of Capital

Weighted average cost of capital shows the cost of capital of the firm which is a mixture of all the sources of funds like shares, preference shares, debentures etc. Every capital is weighed by its percentage of total amount of capital in order to find the cost of each capital type. After this all the costs are added. WACC is mainly used by the investors for identifying the alternative opportunities for investment.

Running Head: Financial Management
[Type the company name]
Financial Management

Financial Management
Contents
2. Weighted Average Cost of Capital....................................................................................................2
2.1 Variables included in the WACC.................................................................................................2
2.2 Results and analysis.....................................................................................................................4
References.............................................................................................................................................6
Appendix...............................................................................................................................................7
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Financial Management
2. Weighted Average Cost of Capital
Weighted average cost of capital shows the cost of capital of the firm which is a mixture of
all the sources of funds like shares, preference shares, debentures etc. Every capital is
weighed by its percentage of total amount of capital in order to find the cost of each capital
type. After this all the costs are added. WACC is mainly used by the investors for identifying
the alternative opportunities for investment (Research Repository, N.D.).
Formula to compute WACC
WACC = (E/V) (Re) + (D/V) (Rd) (1-Tc)
where:
(E/V) = Percentage of common equity in capital structure
(D/V) = Percentage of debt in capital structure
(Re) = Firm’s cost of equity
(Rd) = Firm’s cost of debt
(Tc) = Firm’s corporate tax rate
2.1 Variables included in the WACC
Every company has two sources of funds in order to finance its assets, the one is Equity and
the other is debt. The organizations who wish to have control over the assets of the company
they usually go for debt financing. However, in case of debt financing the company is
required to bear more interest rates as compared to what they bear on equity financing. So the
companies who resist in taking borrowing risk they usually prefer equity financing.
Cost of equity (Re) is the amount a company is required to bear in order to satisfy the
investors. The companies need to evaluate the inputs like firm specific parameters and market
based parameters to calculate an acceptable cost of equity (Queensland Competition
Authority, 2019).
Cost of debt (Rd) is the effective rate of interest that an organisation needs to pay to its
creditors and debt holders.
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Financial Management
The cost of debt to be paid by the firm would be the total amount of interest to be paid less
the tax amount saved. The company would be able to save some amount on tax because tax
deductions are applicable on paid interest (Rd) (1-Tc).
Table 1: Variables Included in WACC calculation of Starhub for the year 2017 and 2018
Values in Millions of
SGD
2017(Starhub) 2018(Starhub)
Market Value Book Value Market Value Book Value
Value of debt (D) 977.5 977.5 1028.5 1028.5
(Book value) (Book value)
Value of equity (E) 4927.832115
605.9
3028.722725
588= no. of
outstanding shares
x $ per share
1729.0639*2.85(yahoo
finance)
1730.6987*1.75
(yahoo finance)
Value of the firm
(V) 5905.332115 1583.4 4057.222725 1616.5
Cost of debt (Rd) 0.0283 0.0283 0.023 0.023
Cost of equity (Re) 0.0588 0.0588 0.0766 0.0766
Corporate tax rate
(Tc)
18% 18% 18% 18%
59.8/333.3 (Total Tax expense/ EBT) 44900/245,500 (Total Tax expense/ EBT)
Weights: 16.55% 16.00% 25.35% 24.20%
Wd = (D/V)
Weights:
83.4% 80.7% 74.7% 71.1%We = (E/V) = (1-
D/V))
WACC
5.29% 5.12% 6.19% 5.90%= (E/V) (Re) +
(D/V) (Rd) (1-Tc)
Table 1: Variables Included in WACC calculation of Singtel for the year 2017 and 2018
Values in Millions
of SGD
2017 (Singtel) 2018 (Singtel)
Market Value Book Value Market Value Book Value
Value of debt
(D)
10430.2
10430.2
10430.2
10430.2
(Book value) (Book value)
Value of equity
(E) 58431.67168
28213.6
48311.64
29653.6
= no. of
outstanding
shares x $ per
16321.696*3.5800 16321.5*2.96
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share
Value of the
firm (V) 68861.8717 38643.8 58741.84 40083.8
Cost of debt
(Rd) 0.02 0.02 0.0242 0.0242
Cost of equity
(Re) 0.0757 0.0757 0.1039 0.1039
Corporate tax
rate (Tc)
15% 15% 11% 11%
684.4/4515.4 (Total Tax expense/ EBT)
701.2/6131.5 (Total Tax expense/
EBT)
Weights:
15.15% 14.90% 17.76% 15.90%
Wd = (D/V)
Weights:
84.9% 85.1% 82.2% 84.1%We = (E/V) =
(1-D/V))
WACC
6.68% 6.69% 8.93% 9.08%= (E/V) (Re) +
(D/V) (Rd) (1-
Tc)
2.2 Results and analysis
Investors usually calculate WACC in order to decide whether they should go for a particular
investment or not. WACC is nothing but it is the minimum rate of return at which an
organization is able to provide and create value for the ones who have invested in the
company. In case, the company has a WACC less than the generated return it simply means
that the company is unable to create value for its investors. Such investment is considered as
unfavorable investment. However, when WACC of a company is more than the return
generated, then such investment is considered to be a favorable investment. So WACC is
considered as a kind of tool made for the reality check.
The top management of any organization usually employs the calculation of WACC before
investing in any of the project. When investment is made in a project with same kind of risk
as that involved in the existing project of the company, then a suitable benchmark rate can
usually be considered for deciding upon whether to accept or reject the project. In case the
project is with different risk then WACC could be used by the company to decide upon
accepting or rejecting the project for investment purpose (Reserve Bank of Australia, 2015).
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In case of Starhub, it has a WACC of 6.19% in the year 2018, so if it needs to invest in a
project which has a higher risk than that of Starhub then it should use the discount rate which
is more than 6.19%.
Likewise, in case of Singtel, it has a WACC of 8.93% in the year 2018, so if it needs to invest
in a project which has a higher risk than that of Singtel then it should use the discount rate
which is more than 8.93%.
In 2017, Starhub gave a return of 83.4% and had a WACC of 5.29%. From here we can
interpret that Starhub was able to create 78.11 cents of value for every dollar it invested into
capital whereas in 2018, the return was 74.7% and WACC of 6.19% so here the company
created 68.51 cents of value for every dollar it invested into capital.
In 2017, Singtel gave a return of 84.9%and had a WACC of 6.68%. From here we can
interpret that Singtel was able to create 78.22 cents of value for every dollar it invested into
capital whereas, in 2018, the return was 82.2% and WACC of 8.93% so here the company
created 73.27 cents of value for every dollar it invested into capital.
Individually, both the companies had performed better in the year 2017 as compared to 2018
but comparatively Singtel is better for investment over Starhub because the WACC of
Singtel had gone up from 6.68% to 8.93% which shows a positive sign of return from the
investment point of view.
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References
Research Repository, (N.D.). Firm type, feed-in tariff and wind energy investment in
Germany: An investigation of decision making factors of energy producers regarding
investing in wind energy capacity. [Online]. Available 21 May, 2019 https://research-
repository.st-andrews.ac.uk/bitstream/handle/10023/13870/15_JIE_5116.REVISED_MANU
SCRIPT_AM.pdf?sequence=1.
Reserve Bank of Australia, (2015). Firm’s Investment Decisions and Interest Rates. [Online].
Available 21 May, 2019 https://www.rba.gov.au/publications/bulletin/2015/jun/1.html.
Queensland Competition Authority, (2019). Cost of Equity. [Online]. Available 21 May, 2019
http://www.qca.org.au/Other-Sectors/Research/Cost-of-Capital/Cost-of-Equity.
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Appendix
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