10/12/11

Hey guys,

I was wondering if anyone could help explain how WACC might be different for industries? I understand that debt is cheaper than equity, and that start-ups would have less debt than mature companies, but what about between industries?

Specifically, I am looking for how WACC differs between real estate, technology, retail, and financial services companies??

Thanks!

Comments (21)

10/12/11

srsly?

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10/12/11

I guess I will take this seriously, thought Kraken's comment illustrates that he thinks you don't understand WACC very well.

Weighted Average Cost of Capital is exactly that - the price (in interest) it costs to borrow money for a company. Debt is cheaper than equity because debt-holders have claims on the assets of the business. Equity holders only have claims on earnings (which presumably also go to turning into assets.)

For this reason, WACC can't be generalized between industries. Sure, there might be a prevailing trend in an industry to have high WACC - but that is because the equity risk premium is high, not because of a industry trend specific issue.

As an illustration, lets say you have debt of 2million(i=4%), common stock of 5 million(i=11%) and preferred stock of 3 million (requiring i=7%).

Then you have a WACC of (2/10)(.04)+(5/10)(.11)+(3/10)(.07) = 8.4%

You have to realize this is all capital structure related and you can't really generalize.

10/14/11
ChicagoIBD:

I guess I will take this seriously, thought Kraken's comment illustrates that he thinks you don't understand WACC very well.

Weighted Average Cost of Capital is exactly that - the price (in interest) it costs to borrow money for a company. Debt is cheaper than equity because debt-holders have claims on the assets of the business. Equity holders only have claims on earnings (which presumably also go to turning into assets.)

For this reason, WACC can't be generalized between industries. Sure, there might be a prevailing trend in an industry to have high WACC - but that is because the equity risk premium is high, not because of a industry trend specific issue.

As an illustration, lets say you have debt of 2million(i=4%), common stock of 5 million(i=11%) and preferred stock of 3 million (requiring i=7%).

Then you have a WACC of (2/10)(.04)+(5/10)(.11)+(3/10)(.07) = 8.4%

You have to realize this is all capital structure related and you can't really generalize.

You forgot the tax shield on the debt, but other than that this is a good synopsis.

10/12/11

I think he means what are normal rates for wacc in those industries, not how the calculation differs...

I hear of stupid analysts asking interviewees this question all the time (what would be a reasonable wacc for say a tech company)

I think its a stupid question.

Side note: in industry sometimes people get told let's make WACC "X" because then company value will be "Y" (not at my firm but heard this from friends). Basically the senior banker just likes a % for a sub-sector because that's what he uses.

10/14/11

Have you tried calculating WACC based on comparables?

OE

10/14/11

^ It wouldn't be correct since there may be significant differences in capital structure, growth potential, market dynamics etc.

Some companies provide their WACC in the notes to the financial statements. You can always start from there. Good luck.

10/14/11

Calculate it yourself or check on a bloomberg terminal?

10/14/11

i don't have access to bloomberg...so anything else? say if I just want to find sample ones, like what have people used to value Microsoft, what have analysts used to value Apple, etc?

10/14/11

Check an initiation report if you have access and analysts will sometimes disclose their WACC in the report

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10/12/11
rom831:

Hey guys,

I was wondering if anyone could help explain how WACC might be different for industries? I understand that debt is cheaper than equity, and that start-ups would have less debt than mature companies, but what about between industries?

Specifically, I am looking for how WACC differs between real estate, technology, retail, and financial services companies??

Thanks!

As was already suggested, WACC is a function of capital structure. Certain industries are more capital-asset intensive than others (think about what capital assets are needed to run, say, an airline, versus a software company). Companies in industries that are capital-asset intensive can usually get debt debt more easily (and more cheaply) than firms operating in industries that are not capital-asset intensive, because such firms have more collateral (e.g. the capital assets) to pledge against debt. For this reason, you won't often see software companies carrying a lot of debt on their balance sheets, because lenders don't like lending against intangible assets such as intellectual property (which tend to be the most valuable assets these firms own).

I hope that helped to answer your question. Feel free to PM me if you need further clarification. Also, you might find this interesting: http://w4.stern.nyu.edu/~adamodar/New_Home_Page/da...

Notice how firms in software, advertising, drugs, and 'Internet' tend to have the highest cost of debt? These are all relatively low capital-asset intensive industries.

Cheers,
BuyersRemorse

10/14/11

Holding leverage constant you're essentially asking which industries have the lowest beta. So which industries are mostly uncorrelated with the general economy. Consumer staples, utilities, healthcare, etc are good examples.

10/14/11

Utilities, government, life insurance, commercial banking. No facts behind that--just a logical guess.

10/14/11

Fin. Svcs., Utilities, etc. Look for higher debt in general.

Dr. Damodaran's spreadsheet: http://w4.stern.nyu.edu/~adamodar/New_Home_Page/datafile/wacc.htm

"I like money (as do most females) but love is...great :)"-student
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Omnia

10/14/11

I'm surprised life insurance is so high. My father was a life insurance executive (CFO) for a Fortune 500 company. It was the steadiest, easiest money ever with ridiculously predictable cash flows. But there you have it...

10/14/11

The cost of debt is cheaper than equity so you would first look for highest levered industries, i.e. those with large, steady and predictable cash flows that can hold a higher % of debt on balance sheet. Consumer staples is not generally included in this category since earnings can be pretty cyclical but the larger chains have the ability to finance assets with negative working capital for which the cost is zero. Another way to find out is looking at which organisations have the best credit ratings..

10/14/11

Damodaran is the man.

10/12/11

Buyers- That is exactly what I was looking for. Thanks!

10/12/11
10/12/11
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