Converting Post-tax WACC to Pre-tax

Yasaswi Gomes new (Finance ) (4474 Points)

28 December 2022  

Hi,

In practice, most entities start off with a post-tax discount rate (as they often use WACC as a start or even as a surrogate measure of the discount rate for impairment purposes) and convert that into a pre-tax rate. Furthermore, many academics and valuation professionals recommend using a post-tax discount rate and post-tax cash flows. Practice also differs between regulators with some taking a more relaxed stance when entities use a post-tax discount rate. Here's how one can convert Post-tax to Pre-tax discount rate for VIU calculations.

Type of capital            
                  Weights             Costs of capitals          Post-WACC 
5 year bond 5%     10000 0.20 5.1% 1.0%
10 year debentures     10000 0.20 4% 0.8%
Bank loan     10000 0.20 5% 1.0%
10 year preference shares   10000 0.20 5% 1.1%
Ordinary equity     10000 0.20 8% 8.0%
        Post-tax WACC   12%
        Pre-tax WACC 17%  
          Gearing   80%

Pre-tax WACC formula= Gearing*(cost of Bonds + Debentures + Term loan + Preference share capitals) + (1/(1-Corporat tax)) * Ordinary Equity cost of capital * (1-Gearing).

Post-tax WACC is calculated by multiplying the cost of each capital source (debt and equity) by its relevant weight, and then adding the products together to determine the value

Please post if there is another method below.

 

Txs