Witt WAC Case Study
Be prepared to Justify your choice. As risk-free rate 7. 2 % is used since it is long term government treasury bond rates and it is assumed that government always pays and no bankruptcy will occur and in cost of capital long term cash flows are considered. B. What risk premium did Ho use? How did you obtain this estimate? As risk premium given average on long term equity annual return is used.
Since it is not easy to observe the market premium, long term historical data on equity return is better. C. Is your estimate of Lee’s cost of equity appropriate as a discount rate for Lee’s total operating cash flows?
NH or why not? For torture cash tools, evaluation is done Witt WAC rate which consists trot cost to equity and cost of debt in a weighted average. In this case, using cost of equity is not appropriate since we doesn’t know cost of debt and weights of equity and debt, it doesn’t reflect the actual rate for WAC. 3.
If Alex had no debt in its capital structure, “hat would be its cost of capital? How could this estimate be used to value Alex? If Alex operated with essentially no leverage in its capital structure and then added a moderate amount of debt, how would this affect its total value?
How might we capture this value impact of debt in our valuation analysis? If company doesn’t have any debt, it means that WAC is equal to cost of equity. There are two ways of increasing capital, (1) using debt and (2) issuing new shares. For profitable companies sometimes it is cheaper to use debt instead of issuing new shares since cost of debt is tax shielded. In this case company didn’t have any debt in past which means less default risk, it will affect total value in a positive way. It will decrease the taxes paid and increase net income, accordingly share values. 4.
Alex use a single corporate-wide discount rate or multiple discount rates (one for each line of business) to evaluate investment projects? Be prepared to explain your answer. If you recommended using multiple discount rates, what rate would you use for Automotive Distribution investments? For Contract Hire investments? For Property real estate) investments? Since each division has different risks it is recommended to use multiple discount rates for each line of business. WAC=Debt Ratio*Cost of -Tax Rate)+Equity Ratio*Cost of Equity Cost of Quitters-free Rate+(Market Rate-Risk-free Rate)*Beta