Taylor Anderson
INTRODUCTION
Background
Pioneer Petroleum was founded in 1924, through a merger within industrial, pipeline transportation, and refining fields. PP has evolved over the last 60 years into a company that now also works with agricultural chemicals, plastics, and real estate development concentrating in gas, oil, petrochemicals, and coal. In 1990, PP improved their coker and sulfur recovery facility to make their refining process more efficient and in turn has become one of the lowest cost refiners on the West Coast. Due to the refining process PP’s gasolines are among the most cleanest-burning in the industry. PP’s is also the producer of one-third of the world’s supply of methyl tertiary butyl ether (MTBE), which is a
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68-69) | Ki=7.8%+(16.25%-7.8%)0.8 | Ki=14.56% |
Weighted average cost of capital | | | | | | | | | | Kw=KD(WtD)+Ki(Wti), where WtD=50% and Wti=50% (p.66) | Kw=7.92%(50%)+14.56%(50%) | Kw=11.3% |
Analysis of Alternatives In recalculating PP’s WACC correctly their actual average cost of capital came out to be 11.3% as opposed to the 9% that PP has calculated. This shows that PP underestimated their WACC by 2.3% due to the fact that they set equity at 10%. If PP chooses to continue to use their single cutoff rate based on the company’s overall WACC, they will now have a cutoff of 11.3%. Again, the problem with using the single rate method is that it does not allow use to see, or account for the differences in each division of PP. Another problem with the single cutoff rate is that due to the increased rate PP will invest their funds in higher return projects which will result in higher risk. This risk is a result of only the high-risk divisions being able to exceed the single rate hurdles using the single rate cutoff method. If PP chooses to go with the multiple cutoff rate approach it allows them to create cutoff rates that reflect the risk-profit characteristics of the individual economic sectors in which PP’s subsidiaries operate. In order to do this you need to determine the equity, debt, and WACC of each firm for each sector as opposed to the single cutoff
General speaking, WACC is the rate that a company’s shareholders expect to be paid on average to finance its assets, and it is the overall required return on the firm as a whole. Therefore, company directors often use WACC to determine whether a financial decision is feasible or not. In this case, I will choose 9.38% as discount rate. The reason why I choose 9.38% as discount rate is because the estimated Debt/Equity is 26% under the assumptions by CFO Sheila Dowling, which is most close to 25% of Debt/Equity from the projected WACC schedule. There might be some flaws existing by using WACC as discount rate. As we know, the cost of debt would be raised significantly as the leverage increased. The investment will definitely increase the firm’s current debt. So, the cost of debt would not keep at 7.75%.
To relever the βe, we use the formula, βe = βu +(D/E)*(βu-βd). And the “Target D/E” was found by taking “Target D/V” divided by “1-Target D/V”. So we get the new βe, 1.3576. Then to get cost of equity, we use the CAPM formula, Re=Rf+β(EMRP), 11.7679%. Since we have get the cost of equity and cost of debt, we can determined the WACC, which is equal to Equity/Value*Cost of Equity+Debt/Value*Cost of Debt*(1-tax rate). In the end ,we arrived at 8.48%.
Weighted Average Cost of Capital (WACC) is the combined rate at which a company repays borrowed capital and comes from debit financing and equity capital. WACC can be reduced by cutting debt financing costs, lowering equity costs, and capital restructuring. In order to minimize WACC, companies can issue bonds by lowering the interest rate they offer to investors as well as, cutting down
Currently, Starbucks is considering making an investment in a new manufacturing plant in Augusta, GA. The capital budgeting project requires an initial investment outlay of $ 40 million and is expected to general annual cash flows of 5.200.000, 6.500.000, 8.200.000, 8.700.000, 9.000.000, 9.550.000, and 11.500.000 for years 1 to 7, respectively. Starbucks estimates that the project has a below-average risk and sets the discount rate at 8.06 % -- based on the company’s Weighted Average Cost Of Capital (WACC). The discount rate is effectively the desired return on an investment an
I used WACC as the discount factor, we expect the rate of return to be higher than it, the same at least. The WACC reflects the average risk and overall capital structure of the entire firm [2]. It’s the required return and it presents how much the company pays for the capital it finances. In this case, the cost of equity is 10.33%, the cost of debt is 6.50%. I calculated WACC using those numbers and got a result of 8.49%.
Since this project is a going concern, the levered terminal and present values are calculated using the weight average cost of capital (WACC) as the discount rate, which we calculate to be 16.17%.
The mixture of debt-equity mix is important so as to maximize the stock price of the Costco. However, it will be significant to consider the Weighted Average Cost of Capital (WACC) as well so that it can evaluate the company targeted capital structure. Cost of capital (OC) may be used by the companies as for long term decision making, so industries that faced to take the important of Cost of capital seriously may not make the right choice by choosing the right project(Gitman’s, ).
At first, WACC and CAPM was attempted to be used as a source of cost of capital. However, for WACC, there is no available proportion of debt and cost of debt for MW. For CAPM, no available data seems to support the acceptable
Moreover, let’s calculate the Weighted Average Cost of Capital (WACC). And in order to calculate it we need to know the capital structure of the company. Knowing the capital structure of the
A key factor in determining a project's viability is its cost of capital [WACC]. The estimation of Boeing's WACC must be consistent with the overall valuation approach and the definition of cash flows to be discounted. Note that this process is a forward looking focus and is laden with uncertainty. It is how the assumptions are modeled that many costly mistakes can be made. While finding a rate of return for an individual project, it is important to remember that WACC is only appropriate for an individual project.
The calculation mentioned above shows some assumptions of WPC when they valuate the stock range of Interco. However, some assumptions should be questioned:
For future cash flows, evaluation is done with WACC rate which consists from cost of 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 WACC.
Before recapitalisation Wrigley’s WACC was equal to it’s cost of equity (ke), which was calculated at 10.95%. After capitalisation it was found that Wrigley’s WACC decreased to 10.29%. This follows the general pattern of increasing debt resulting in a lower WACC.
All of these calculated figures can then be used to calculate the WACC which is (17% x 3.47%) + (83% x 11.2%) = 9.87% WACC. This WACC percentage can then be used to value the investment and as a comparative in valuation methods. The full calculation and numerical values are shown in Appendix 1.
Marriot’s cost of capital is the weighted average of the cost of company debt and the cost of company equity, which is mathematically the same as the weighted-average of the divisional costs of capital weighted based on net identifiable assets.