The main objective of conducting this project is to perform an analysis about the WACC which refers to the weighted average cost of capital which is a very widely used term in the finance world. For my analysis, I chose to calculate and compare the WACC of some companies that I have chose; I searched for many terms and calculated many terms in order to have the final WACC result of each company. I chose two companies from the same industry which is auto manufacturing industry. Those companies are Toyota and Honda. On the other hand, I also chose another three companies operating in the same industry which are IBM, Microsoft, and Hewlett Packard which I will compare among them later in my project paper.
WACC Introduction:
WACC is simply cost of capital and as a result firms are interested by a lower value of WACC. As a matter of fact, every company's assets are usually financed either by its debts or by its equities and in addition to this; weighted average cost of capital is the average of the costs of these sources of financing the company's assets. The first two words from WACC which stands for Weighted Average means that it's actually a weighted average of how much interest the company has to actually pay for each single dollar that it has to finance. This WACC value gives investors an insight of whether it will be profitable to invest or not in a specific particular firm, as it's a measure of the minimum rate of return or what is called discount rate in which a firm creates value for its investors. As a matter of fact, the WACC and the Beta as well as the rate of return on equity all are directly proportional to each other. That is, whenever Beta and rate of return on equity increases, WACC as a result will tend to increase too, and therefore, this represents a decrease in valuation which means a higher risk. To simplify further, by calculating a company's WACC, an overview of how much interest the company has to pay for each dollar it has to finance is being provided.
WACC terms:
In order to be able to calculate WACC easily, we have to be able to calculate these values first and they are the following:
Percentage of equity
Percentage of debt
Cost of equity
Cost of debt
Tax rate
Formulas used to calculate WACC:
More than one formula exists in providing us with methods to calculate WACC; however, I found the traditional and most common way of calculating it the simplest and therefore I will stick to it in my project when calculating WACC for the five companies that I chose which are Toyota, Honda, IBM, Microsoft, and Hewlett Packard. This is the general formula for calculating the weighted average cost of capital:
Percentage(E)*Cost(E)+(1- Tax rate)*Percentage(D)*Cost(D)
Where:
E: Equity, D: Debt
How the terms are calculated:
Percentage (E) formula: Market value Equity/ (Market value Equity + Net Debt)
Market value of equity formula: (No. of shares outstanding * Market value per share)
Net debt formula: (Book value of debt - Cash on hand), where Book value of debt is found by multiplying the Total Book value of equity by Debt and then subtracting equity ratio,; Total Book value of equity is Book value of equity * No. of shares outstanding.
Percentage (D) is 1- Percentage (E)
Cost of equity formula(Re): Risk free+Beta*(Expected return - Risk free
Cost of debt (Rd) is the average interest expense
Chosen Companies Overview:
3.1 Toyota Company:
Toyota motor corporation or what is known as Toyota is considered a multinational company operating and distributing its products worldwide as it's the largest automaker company in terms of sales generated by them. Toyotas founder is Kiichiro Toyoda.
This company has about 522 subsidiaries and its production isn't limited to producing automobiles only, but also provides some financial services as well as it also builds robots. This company was hit greatly by the Financial Crisis as it recorded huge losses.
Toyota as a result of expanding its activities worldwide and has placed General Motors and became the world's largest automaker in 2008 as well as it was given the title of the most profitable automaker in 2008 too. Moreover to this, Toyota is considered to be the fifth largest company in the world according to statistics done by the Fortune Global 500.
Currently, Toyota is known to be the largest automaker worldwide in terms of sales generated, profits and revenues generated. Also, this company have been a constant leader in the industry as well as proved to be more productive than its competitors.
Year Founded
1937
Industry
Auto manufacturers- Major
Headquarters
Tokyo, Japan
Dividends
1.45
Dividend Yield
1.70%
Market Capitalization (billion)
133.96
Earning per share (EPS)
-6.76
Shares outstanding(billion)
1.57
Current ratio
1.204
Number of employees
322,650
Total assets in 2008(billion $)
323.968
Asset growth(billion)
= (TA 2008 - TA 2007)/TA 2007
= (323.968 - 275.941)/ 275.941
= 17.4%
Profitability
Profit margin
Operating Margin
-5.90%
-7.06%
http://en.wikipedia.org/wiki/Toyota
http://finance.yahoo.com/q?s=TM
3.2 Honda Company:
Honda Motor Company is also a Japanese firm which is a worldwide automaker of automobiles as well as motorcycles. Also, it's considered the world's largest motorcycles manufacturer as well as the largest engines manufacturer produced on a yearly basis.
In 2001, Honda became the second largest automobile manufacturer in Japan.
On the other hand, in 2008, it became the fourth largest automaker in the U.S as well as the sixth automaker worldwide. This international automaker company was founded by Soichiro Honda at a young age.
Year Founded
1948
Industry
Auto manufacturers - major
Headquarters
Tokyo, Japan
Market Capitalization (billion)
123.03
Earning per share (EPS)
-0.29
Shares outstanding(billion)
3.63
Current ratio
1.319
Number of employees
177,544
Total assets in 2008(billion $)
127.416
Asset growth(billion)
= (TA 2008 - TA 2007)/TA 2007
= (127.416 - 102.310)/ 102.310
= 24.5%
Profitability
Profit margin
Operating Margin
-1.17%
-0.94%
http://finance.yahoo.com/q/ks?s=HMC
http://en.wikipedia.org/wiki/Honda
3.3 IBM's Company:
IBM which stands for International Business Machines is well-known for the pat years as a global and worldwide computer software as well as hardware in addition to technology and Information technology Consultation Corporation. This popular company has been well known as the world's largest company dealing with computers and systems.
Moreover, it's the largest and the most generating profits in the world. Products of IBM are being distributed in about more than 170 countries worldwide and it has been earning a lot of prizes and awards across the past years and currently. IBM was founded by the great founder Herman Hollerith. IBM creates value for its customers by solving consumer needs and clients problems, coming up with solutions which have an influence on information technology by reducing off costs.
Year Founded
1911
Industry
Diversified computer systems
Headquarters
New York, United States
Dividends
2020
Dividend Yield
1.70%
Market Capitalization (billion)
171.95
Earning per share (EPS)
9.74
Shares outstanding(billion)
1.31
Current ratio
1.318
Number of employees
410,097
Total assets in 2008 (billion $)
$109.524
Asset growth(billion)
= (TA 2008 - TA 2007)/TA 2007
= (109.524 - 120.431) / 120.431
= -9.05 %
Profitability
Profit margin
Operating Margin
13.65 %
19.35 %
http://en.wikipedia.org/wiki/IBM
3.4 Dell's Company:
Dell Company is a multinational international firm which creates, develops, produces, and distributes PC's as well as other computer related materials all over the world. This company was founded by Michael Dell and it has been growing and expanding its activities worldwide. It has been given the second position in computer sales within its industry. According to the Fortune 500 list, Dell is ranked the 25th largest company. Dell has been performing beyond the expected for the past fifteen previous years. A lot of competitors rival against each other in the computer industry and field and so Dell has many competitors including IBM which we discussed earlier and Hewlett Packard which will be discussed later in addition to many other competitors such as Toshiba, Acer, Sony, Apple, etc..
Year Founded
1984
Industry
Personal Computers
Headquarters
United States
Market Capitalization (billion)
28.10
Earning per share (EPS)
0.74
Shares outstanding(billion)
1.96
Current ratio
1.475
Number of employees
76,500
Total assets in 2008( billion $)
27.561
Asset growth(billion $)
= (TA 2008 - TA 2007)/TA 2007
= (27.561 - 25.635)/25.635
= 7.5%
Profitability
Profit margin
Operating Margin
2.82%
5.05%
http://en.wikipedia.org/wiki/Dell
http://finance.yahoo.com/q/ks?s=DELL
3.4 Hewlett Packard's Company:
Hewlett Packard was founded by two men William Hewlett and David Packard. It's a client electronics firm which is known as the worlds largest technology company operating in about every country located on the globe.
Hewlett Packard specializes in creating and distributing computers, software's, hardware's, as well as storage media and networking devices. HP products are being diversified to various different levels of consumers including small households, small to medium businesses, retailers, and yet many others. In 2006, HP generated annual revenue larger than that of IBM's. It's considered the ninth largest company according to fortune 500 list. Also, it's commonly considered as the sixth largest software company worldwide as in 2008, it gained its global leadership position in most printer type's including inkjet and laser.
Hewlett Packard improves its services not limiting itself to producing hardware and software but emerges to a wide variety of services including designing, implementing, as well as supporting the information technology infrastructure.
Year Founded
1939
Industry
Diversified computer systems
Headquarters
California, United States
Dividends
0.32
Dividend Yield
0.60%
Market Capitalization (billion)
121.78
Earning per share (EPS)
3.14
Shares outstanding(billion)
2.36
Current ratio
1.222
Number of employees
304,000
Total assets in 2008( billion $)
113.331
Asset growth(billion)
= (TA 2008 - TA 2007)/TA 2007
= (113.331- 88.699)/88.699
= 27.7%
Profitability
Profit margin
Operating Margin
6.69%
9.62%
http://en.wikipedia.org/wiki/Hewlett_Packard
http://finance.yahoo.com/q/ks?s=HPQ
4.0 WACC Results
4.1 Toyota Company:
Computing Toyotas WACC (2008)
Equity Beta, βE
0.67
Shares outstanding (million)
1570
Market value per share
77.02
Market value of equity (M), E
120921.40
Book value of equity per share
72.779999
Total book value of equity
114264.5984
Total debt(millions)
205498
Total Equity(million)
118470
Debt/Equity ratio
1.734599477
Book value of debt
198203.3126
Cash on hand(million)
176
Net debt(M), D
198027.31
Risk free rate
0.84%
Market P/E
9.52
growth of market dividends
25.00%
Payout ratio of market
28.06%
E(r M)=
28.68%
Year
2008
2007
Interest exp.(millions)
460
418
Long term debt(millions)
59706
53059
Current maturities of LTD(millions)
62163
49868
Total debt at the end of the year
121869
102927
Average interest expense, Rd
0.41%
Year
2008
2007
Income before taxes(EBT) in million
24326
20182
Income taxes
9098
7609
tax rate
37.40%
37.7%
Average tax rate, Tc
37.55%
Computation of WACC
Percentage of equity, E/(E+D)
0.379
Percentage of debt, D/(E+D)
0.621
Cost of equity, Re
19.50%
Cost of debt, Rd
0.41%
Tax rate, Tc
37.55%
Toyota WACC 2008
7.55%
4.2 Honda Company:
Computing Hondas WACC
Equity Beta, βE
0.73
Shares outstanding (million)
3630
market value per share
33.99
market value of equity (millions), E
123383.7
Book value of equity per share
12.71
Total book value of equity
46137.3
Total debt(millions)
81519.908
Total Equity(million)
45897.077
Debt/Equity ratio
1.776145962
Book value of debt
81946.57911
Cash on hand(million)
10614.11
Net debt(million), D
71332.46911
Risk free rate
0.84%
Market P/E
11.82
growth of market dividends
4.22%
Payout ratio of market
41.00%
E(r M)=
7.84%
Year
2008
2007
Interest exp.(millions)
167.89
109.752
Long term debt(millions)
18550.185
16198.82
Current maturities of LTD(millions)
25837.467
17350.86
Total debt at the end of the year
44387.652
33549.67
Average interest expense, Rd
0.43%
Year
2008
2007
Income before taxes(EBT),millions
9047.994
6739.378
Income taxes(millions)
3913.104
2412.619
tax rate
43.2%
35.8%
Average tax rate, Tc
39.5%
Computation of WACC
Percentage of equity, E/(E+D)
0.633659241
Percentage of debt, D/(E+D)
0.366340759
Cost of equity ,Re
5.95%
Cost of debt, Rd
0.43%
Tax rate, Tc
39.5%
Honda WACC 2008
3.863%
IBM's Company:
Computing IBM WACC
Equity Beta, βE
0.73
Shares outstanding (Million)
1310
Market value per share
129.68
Market value of equity (Million), E
169880.8
Book value of equity per share
14.004
Total book value of equity
18345.24
Total debt(millions)
96058
Total Equity(million)
13466
Debt/Equity ratio
7.133372939
Book value of debt
130863.4386
Cash on hand(million)
12741
Net debt(million), D
118122.4386
Risk free rate
0.84%
Market P/E
13.54
Growth of market dividends
26.67%
Payout ratio of market
22.00%
E(r M)=
28.73%
Year
2008
2007
Interest exp.(millions)
673
611
Long term debt(millions)
23391
23573
Current maturities of LTD(millions)
11236
12235
Total debt at the end of the year
34627
35808
Average interest expense, Rd
1.91%
Year
2008
2007
Income before taxes(EBT),millions
16715
14489
Income taxes, (millions)
4381
4071
Tax rate
26.21%
28.10%
Average tax rate, Tc
27.15%
Computation of WACC
Percentage of equity, E/(E+D)
0.590
Percentage of debt, D/(E+D)
0.410
Cost of equity, Re
21.20%
Cost of debt, Rd
1.91%
Tax rate, Tc
27.15%
IBM WACC 2008
13.07%
4.4 Dell's Company:
Computing Dells WACC
Equity Beta, βE
1.28
Shares outstanding (million)
1960
market value per share
13.21
market value of equity (millions),E
25891.6
Book value of equity per share
2.569
Total book value of equity
5035.24
Total debt(millions)
23732
Total Equity(million)
3735
Debt/Equity ratio
6.35394913
Book value of debt
31993.65882
Cash on hand(million)
7764
Net debt(million), D
24229.65882
Risk free rate
0.84%
Market P/E
17.84
growth of market dividends
0.00%
Payout ratio of market
0.00%
E(r M)=
0.00%
Year
2008
2007
Interest exp.(millions)
45
45
Long term debt(millions)
362
569
Current maturities of LTD(millions)
225
188
Total debt at the end of the year
587
757
Average interest expense, Rd
6.70%
Year
2008
2007
Income before taxes(EBT),millions
3827
3345
Income taxes(millions)
880
762
tax rate
23.0%
22.8%
Average tax rate, Tc
22.9%
Computation of WACC
Percentage of equity, E/(E+D)
0.516579204
Percentage of debt, D/(E+D)
0.483420796
Cost of equity, Re
-0.24%
Cost of debt, Rd
6.70%
Tax rate, Tc
22.9%
Dell WACC 2008
2.375%
Hewlett Packard's Company:
Computing Hewlett Packard's WACC
Equity Beta, βE
1
Shares outstanding (million)
237
Market value per share
50.71
Market value of equity (M), E
12018.27
Book value of equity per share
17.125
Total book value of equity
4058.625
Total debt(millions)
74389
Total Equity(million)
38942
Debt/Equity ratio
1.910251143
Book value of debt
7752.993044
Cash on hand(million)
10153
Net debt(M), D
-2400.006956
Risk free rate
0.84%
Market P/E
16.13
growth of market dividends
13.50%
Payout ratio of market
11.00%
E(r M)=
14.27%
Year
2008
2007
Interest exp.(millions)
329
289
Long term debt(millions)
7676
4997
Current maturities of LTD(millions)
10176
3186
Total debt at the end of the year
17852
8183
Average interest expense, Rd
2.53%
Year
2008
2007
Income before taxes(EBT) in million
10473
9177
Income taxes
2144
1913
tax rate
20.47%
20.8%
Average tax rate, Tc
20.66%
Computation of WACC
Percentage of equity, E/(E+D)
1.250
Percentage of debt, D/(E+D)
-0.250
Cost of equity, Re
14.27%
Cost of debt, Rd
2.53%
Tax rate, Tc
20.66%
HP WACC 2008
17.34%
Analysis and Comparisons
Toyota
Honda
IBM
Dell
Hewlett Packard
Beta
0.67
0.73
0.73
1.28
1
Return
28.68%
7.84%
28.73%
0%
14.27%
WACC
7.55%
3.863%
13.07%
2.375%
17.34%
Beta is a measure of the sensitivity of the returns of a company to the returns of the market. If Beta is greater than one then it is an aggressive stock and betas less than one are considered defensive stocks and beta equal to one means that it moves in the same direction of the market as Hewlett Packard in my case. Dell is considered an aggressive stock which means that its shares are exaggerating the markets movements with it in contrast to Toyota, Honda, and IBM which are defensive stocks or in other words their shares are more stable.
Another point worth mentioning is that if the company's return is less than its WACC, this means that the company is losing value, which in turn is an indication that investors putting their money in that company should invest anywhere else other than in that company as their money would be losing value, which is the case here in DELL . I found the return to be 0% which is less than its WACC which means that its to Dells investors disadvantage to keep their money invested in DELL's company and should invest it somewhere else far from Dell.
Conclusions
From what I have seen, its noticeable how important is the concept of WACC which is the weighted average cost of capital (WACC) . As I understood, a company is divided into two parts debt and equity. Therefore, lenders in addition to equity holders expect a specific return on the funds or capital that they have been providing for the company, and as everybody know, that the WACC is the cost of capital or the expected return to these people. As a result, WACC represents the investor's opportunity cost which involves taking on the risk of engaging the money or investing it into the company. Usually, investors use WACC to advice them whether to invest or not in the company as it's a representation of the minimum rate of return over which a company produces wealth for its investors.
