Debt in WACC
Hi, guys
I have 2 questions.
1. Please help me understand what debt contains, when calculating WACC
When I calculate debt for WACC, I take following things :
- Commercial papers (short-term debt)
- Revolver debt (short-term debt)
-Long-term debt
-Capital Leases
- Current portions of capital lease and long-term debt
Shoud I add or remove something ?
- Which tax rate is relevant to use when calculating WACC ? Should it be marginal tax rate ? Or just corporate tax rate ?
I would also be glad to learn the answers from IB analysts. What assumptions do you use when calculating WACC ?
Bump for OP -- I would like to know the answer to this too!
the assumptions used for WACC are all over the board. I always recommend that you just assume WACC is 9%. Only somewhat joking.
Anyway, I usually focus on permanent capital structure, which typically doesnt mean commercial paper. It may always be in the capital structure, but it is more of a working capital consideration. I usually use long term debt (incl revolver), but also include cap leases if it is significant. In fact, you may want to capitalize operating leases if they are significant or if your target company is different from industry comps.
You generally want to know the marginal cost of corporate debt - i.e. the cost of borrowing an additional dollar. This cost is generally based on bond rating (determined mostly by leverage, size, industry, cash flow, coverage metrics, etc...) and current credit spreads. Interest expense, nor current coupon are actually accurate representations of a company's true cost of debt and they aren't marginal.
Tax rate should also theoretically be LT marginal, and technically should account for probability of not realizing the tax rate due to default known as G. However, normally (fairness or valuation opinion context) standard 35% tax rate is used since it is not possible for an analyst to correctly calculate LT marginal tax rate (you will rarely know how tax planning works at a firm) and G is generally not calculated due to complexity of option pricing model that is used in theory. Whatever you do, do NOT use the effective tax rate here (i.e. taxes paid / income).
On the weights, yes perm capital structure is technically the right focus, BUT generally this includes CP. Generally if a firm is large enough to have a CP program, they are using this as a significant funding source so it is part of the perm cap structure. However, beyond that point if you think about the risk profile of the FCF you are discounting, then you will realize that it is technically FCF to the full cap stack, including CP/other ST paper, so you need to discount by the appropriate rate.
Guys - need help along the same lines ... what about liabilities like:
short term and long term tax obligations - i believe these typically not included as part of debt in WACC calculations.
What about deferred revenue and accounts payable. Looking for some guidance ...
Deferred Revenue and Accounts Payable are working capital considerations and not included in WACC. Think of what WACC is supposed to represent - the cost of the current capital structure in place. Working capital is not part of the capital structure because it is current assets/liabilities, which are things that can easily change in a short time period. In that regard, what should be included in WACC is obvious - only those long term capital structure items that won't change month to month.
Further, WACC is the cost of capital. Debt and equity both have costs associated with them - what creditors and investors are expecting to receive. Accounts payable isn't claimed by debt or equity holders. There is no expected return for accounts payable aside from the payment.
So keeping these thoughts in mind, you should be able to for the most part ascertain what belongs in WACC.
Now, regarding taxes, this can be somewhat of a gray area depending on the tax position. Though uncommon, some tax positions are actually treated as debt-like, and in that case it might be of value to include in the capital structure.
always marginal tax for WACC
If you guys understand the concepts behind CAPM and WACC it should be obvious that things like AP and DTL are not debt
Cost of debt in WACC analysis (Originally Posted: 11/03/2007)
How do you guys calculate the cost of debt for WACC of a company.
Do you look at the YTW for the latest issuance of the Holding Company on bloomberg?
ytm on long term non option debt....so like their 10 year issuance
Usually a big part of this will be floating debt (i.e. bank debt based on 3m L) - so assume that firm swaps out variable pay for fixed and use that for each varraible-pay tranche of cap structure
When there is more than one bond outstanding, what should be done for cost of debt?
ideas: 1)weighted average 2)Look at the most recent one.
Dear dick_fluid,
I have calculated cost of debt of my company as we discussed. Now, I am going to find debt / equity ratio for WACC. What do you advice for both book value or market value?
Cost of Debt, WACC (Originally Posted: 12/27/2010)
A newbie question - why do you multiply the cost of debt with (1 - tax)? What is the rationale behind this? Thanks
interest expenses are tax deductible, the government is essentially funding a portion of your financing costs. For this reason you often hear that debt is 'cheaper' than equity.
interest expense is deductable on tax returns whereas the components of equity and preferred in wacc (dividends) don't receive the same favorable treatment. Hence, the true cost of debt is the post-tax cost, otherwise Cd * (1-T).
Example, if you pay $100 in dividends, this is part of your cost of equity (indirectly), but doesn't get deducted from federal returns.
If you pay $100 in interest, however, (and all debt consists of is principle + interest) the true amount spent is $60, assuming there is a 40% corporate tax rate because you can deduct that from your corporate returns.
thanks all.
Cost of Debt for WACC (Originally Posted: 06/25/2013)
Where would you find average YTM of all outstanding debt other than individually sifting SEC filings over the years. Tedious calculations if you don't want to "assume"
you probably don't want to use all outstanding debt, but i guess if you did, you could find their different debt offerings on a variety of websites and take a weighted average. Older issuances wouldn't accurately reflect a firm's current cost of capital, I'd probably use only the few most recent offerings. Try morningstar.
For financial leverage sake and an attempt not to skew the cost of debt by low finance rates that may have been taken advantage of recently. The 10-k provides a W/A YTM on outstanding debt. Why would you not want to include all debt ?
It depends on a lot of things and is really up to the analyst's discretion. The simplest way of doing it for your intended purposes (school, I assume) would be too look at all oustanding LT debt on the BS, and look at the various debt obligations as a % of the LT debt (usually there's a chart or two here). Take the weights of each debt obligation, multiply them by their corresponding yield, and sum up the resulting yields. Make sense?
It is for business analyst purposes for personal investments. Essentially for my WACC & Economic profit excel model, I guess the 10-k W/A YTM would be fine, taken in context with other data of course.
Bloomberg but I question your methodology
Why? I am exploring alternative formula inputs...
How to estimate the weighted average cost of debt and equity for the WACC equation (Originally Posted: 01/28/2014)
1SB for the first person who can explain this.
You could use the CAPM to find the cost of equity and look at the debt schedule in the most recent 10k/10q for calculate the WA cost of debt, if they have different kinds. Use market cap and BV of debt to find the weights. Ideally, you're supposed to use MV of debt, but good luck finding it if it isn't publicly traded.
Cost of equity is simple - CAPM. You can also estimate using Dividend Yield + Growth in dividends.
With Cost of Debt, you can use either a credit spread (what rate is lended to a given credit rating over the risk-free rate) or you could use the YTM on a long-term debt security of the company. In both instances you would multiply (1-Marginal Tax Rate).
Thanks
Agree with what IntrospectiveBanker said, but I think it's important to identify exactly what you're using the WACC for.
For example, using CAPM to determine the cost of equity for a huge conglomerate (Beta likely 1 or close to it), might be completely irrelevant if you're trying to analyze a project that lies within a much riskier arm of that company's business.
Additionally, if you're using WACC for a capital restructuring equation (and it's been a while since my corp finance classes, so i might be mistaken), pretty sure you need to factor unlevered Beta into the equation for determining the true riskiness of the debt.
WACC Calc - determining % of debt in the capital structure ? (Originally Posted: 07/17/2017)
Hi,
Sorry if this is an amateurish question, but I am slightly confused when it comes to figuring out how to determine "debt" when calculating the % of debt in a company's capital structure in the WACC calcs.
I've tried using Net Debt, (Net Debt + Cash&Equiv) & (S.T Liabilities + L.T Liabilities) all with widely different results, what is the industry standard ?
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