WACC - Risk Free
What would you guys use right now as a risk free rate? The 10 year bond yield seems to be insanely low, would you use this sub 1% rate? Or go with a past one like 3%. My intuition is you have to go with the very low
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May add a premium for tough financing in this period if you are looking at a live deal rn
For Risk free rate, I would take an average of the past 3-5 years
It all depends in the level of precision you require, but I would also take something very close to 0 percent
Whenever you're calculating something like WACC, you need to step back and see if both the assumptions and results make sense.
Let's say that we use your 1% risk free assumption, What's your market risk premium? What's your beta? If you haven't changed those from the pre-pandemic period (when the risk free rates were higher), then you're saying that it's easier to raise capital right now because the hurdle rate is lower. That obviously doesn't make a lot of sense, so clearly you'd have to adjust both the MRP and beta (both of which should theoretically be higher and should more than offset the lower risk free rate). The problem that you're going to run into is trying to calibrate beta and MRP to 3 months of data (so that your rf, MRP, and beta are on an apples to apples basis i.e. post-pandemic).
That's a long winded way of saying that I'd just use the pre-pandemic assumptions with maybe some kind of premium to reflect the difficulty of capital raising currently (just throw it in a data table and show a range). Obviously, that begs the question of how to set the premium, which I don't think there's a great answer for. That said, your assumption that the current cost of capital is the December or January WACC plus a spread is a lot easier to grok than trying to estimate how the MRPs and betas have changed so as to offset for the decrease in rf.
This is good. I would use the prevailing Rf rate because that can be locked down for 10 years. But adjust the MRP so that the cost of equity numbers make sense.
Also, keep in mind that the default spreads right now are pretty inflated. If you are calculating cost of debt with a spread (rather than int rates) you may want to drop the spread back to where it was pre COVID. I like to look at NYU Stern page and make sure that my numbers are relatively aligned with those data tables.
low risk free is fine, because in theory the market risk premium should be a lot higher which plays a larger role in WACC
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