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DCF - Weights for Cost of Equity & Debt


Rajan (NA)     19 May 2020

Rajan
NA 
 54 points

| My Other Post

Dear All,

Before I post my query, I would like to thank the members of this form, especially, Hariom Viradiya for their inputs.

Now, back to my query, as part of the DCF, I am in the process of identifying the WACC. Further, I have calculated the Ke - Cost of Capital and Kd - Cost of Debt. Now, while calculating WACC, I require the following clarification:

Share Capital & Debt Structure as per Projection:

Present Outstanding Shares – 1,00,000 Equity Shares of Rs. 10/- each

 

Current Year

Year 1

Year 2

Year 3

Year 4

Year 5

Share Capital

10,00,000

10,00,000

10,00,000

10,00,000

10,00,000

10,00,000

Additional Share Capital*

--

--

5,00,000

5,00,000

8,00,000

8,00,000

Securities Premium

20,00,000

20,00,000

20,00,000

20,00,000

20,00,000

20,00,000

Secured Loan (Bank)

3,00,000

5,00,000

3,00,000

5,00,000

5,00,000

10,00,000

* Note: Additional Share Capital included Share Premium

Cost of Equity (Capital) (Ke) - 13.5%

Cost of Debt (Kd) - 17% - Assumed as per projections 

The following are my queries:

1. While calculating WACC, should I use the Market Value of Equity Capital or Book Value of the Equity Capital? If Market Value should be used,

a) how do I determine the Market Value?  

b) Market Value has to be determined as on which date? Present or Year 5?

2. Based on the above, how should I calculate weights, should it be based on Present Share Capital or Year 5 Share Capital & Debt?

Thank you

--

Rajan 

 

avater

Hariom Viradiya   19 May 2020

Hariom Viradiya

 15 likes  169 points

View Profile | My Other Post

I understood your concern but i would like to know what cashflow exactly are you discounting ?
1. Net operating profit after tax or
2. Profit available to equity shareholders

Rajan (NA)     20 May 2020

Rajan
NA 
 54 points

View Profile | My Other Post

I am discounting Net operating profit after taxes.

Rajan (NA)     21 May 2020

Rajan
NA 
 54 points

View Profile | My Other Post

I am discounting Net operating profit after taxes.

avater

yasaswi gomes   24 May 2020

yasaswi gomes

 66 likes  1152 points

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All discount factors are nominal; Market value of debt and equity should be used. 

A) The market value of share and loans.

B) WACC will change Cashflows into PV after discounting= NPV.

Book values means carrying values i.e., value of asset minus any deductions. This also can be projected. But usually, nominal cash, discount factors are used. 

Next, weights are found out using pro rats method. Then, you have to prepare a marginal cost of capital schedule to find out the new WACC after introducing new capital. 

WACC is calculated on the whole debt and equity used to finance a project. If new finance is injected, the WACC increases and more returns should be earned to payback investors. 

Finally, the above table is part of capital budgeting where the finances change. So, WACC will change. To avoid this, all debt and equity required for investment is grossed and deducted from Discounted (WACC) Cashflows in the following years. 

The above table is representing the same number means capital is the same. Add up changes. 

36 lakhs s.capital

32 lakhs loan

This should be your total investment amount for which you will find WACC rate. 

Or

add all six years data for every item. That will be your initial investment. It depends upon your syllabus as to what it is. 

 

 

avater

yasaswi gomes   24 May 2020

yasaswi gomes

 66 likes  1152 points

View Profile | My Other Post

Since the question mentions that share premium is included in capital, Market value is used because premium is already incorporated into the nominal value of share capital. 


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