11/17/2016

HowtofindtheWeightedAverageCostofCapital(WACC)ofaDivisionDefinition|Subjectmoney.com

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HOWTOFINDTHEWEIGHTEDAVERAGECOSTOF
CAPITAL(WACC)OFADIVISION

Forthislessonweareassumingthatyoualreadyhaveadecentconceptualunderstandingof
WeightedAverageCostofCapital(WACC)andhowitiscalculated.Whatwearedoinghere
istakingtheWeightedAverageCostofCapitalConceptonestepfurtherbycalculatingthe
WACCforacompanysdivision.Amajorityoflargecorporationsdobusinessinmany
differentindustries.Thesedifferentdivisionswithinacompanyarenotallsubjecttothesame
economicenvironmentthereforetheyaresubjecttodifferentlevelsofrisk.Forexample,
Boeingbuildsairplanesforcommercialuseandforthedepartmentofdefense.The
commercialdivisionisobviouslygoingtohaveahigherlevelofrisk.Thisriskmeansthat
Boeingscommercialdivisionhasahigherbeta.Ahigherbetameansthatthecostofequity
ishigherandsincethecostofequityishigher,soistheWACCforthecommercialdivision.
NowweknowthattheWACCisthecostofcapital,andforacompanytobeprofitable,it
mustonlytakeonprojectsthathaveanexpectedreturnthatishigherthantheirWACC.

SupposeBoeingneededtomakeadecisiononwhetherornottoacceptaprojectof
developingthenewcommercialaircraft,the7E7.Boeingsmanagementdeterminedthatthe
expectedinternalrateofreturnfortheprojectis17.32%.BoeingscompanyWACCis
11.13%whichissignificantlylowerthantheinternalrateofreturnforthe7E7project.The
problemhereisthatBoeinghasadefensedivisionthatmakesthecompaniesWACCmuch
lower.The7E7projectisacommercialproject,thereforeBoeingneedstofindoutwhatthe
commercialdivisionsWACCis.TheycanthencomparetheInternalRateofReturnofthe7E7
projectwiththeWACCofthecommercialdivision.SohowdowefindtheWACCofthe
commercialdivision?Thefirstthingwewoulddoisfindsomeimportantfiguressuchas
BoeingsCapitalStructure,theircostofdebt,theirbetaandtheirtaxrate.Wewouldalso
needtofindthemarketriskpremiumwhichisdeterminedbytheriskfreerateandthemarkets
rateofreturn.Wearegoingtogiveyouallofthesecomponentsforsimplificationpurposes
butitisimportantthatyouknowhowtofindthesecomponentsonyourown.

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11/17/2016

HowtofindtheWeightedAverageCostofCapital(WACC)ofaDivisionDefinition|Subjectmoney.com

Step1:CalculateBoeingsunleveredbetaUnleveredbetaisalsoknownastheasset
beta.Theunleveredbetaisthebetathatthecompanywouldhaveifitwas100%equity
finance(nodebt).Whenpeoplerefertoastocks(companys)betatheyarereferringtothe
leveredbetawhichisthebetathatisgiven.Theunleveredbetamustbesolvedusingthe
formulabelow.

Step2:CalculatetheunleveredbetaforthedefensedivisionofBoeing

NowthatweknowBoeingsunleveredbeta,weneedtofindtheunleveredbetaof
Boeingsdefensedivision.Wedothisbyfindingcompanies(proxies)thataresimilarto
Boeingsdefensivedivisionandsolvefortheirunleveredbetas.Wethenaveragetheir
unleveredbetas.TheaverageunleveredbetasofourproxieswillbetheBoeingdefense
divisionsunleveredbeta.

Findproxiesfordefensedivision,calculateunleveredbetasandaverageunleveredbetastoget
Boeingsdefensedivisionsunleveredbeta.

OurproxiesthatweareusingareLockheadMartinandNorthropGrummenbecausetheyare
defensecontractorsthatoperateinindustriesmostcloselyrelatedtoBoeing.

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11/17/2016

HowtofindtheWeightedAverageCostofCapital(WACC)ofaDivisionDefinition|Subjectmoney.com

Step3:CalculatetheunleveredbetaforBoeingscommercialdivision.

NowthatweknowanestimateofBoeingsdefensedivisionsunleveredbetaweareable
tocalculatetheunleveredbetaofthecommercialdivision.Wealreadyknowtheunlevered
betaforBoeing,theweightsinwhichBoeingoperates(46%indefense&54%incommercial)
andtheunleveredbetaforthedefensedivision(.2296).

Step4:CalculatetheBoeingscommercialdivisionsleveredbeta.

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11/17/2016

HowtofindtheWeightedAverageCostofCapital(WACC)ofaDivisionDefinition|Subjectmoney.com

NowthatwehavetheunleveredbetaforBoeingscommercialdivisionweareableto
calculatetheleveredbetaofBoeingscommercialdivision.Wewouldsimplypluginthe
correctinputstotheformulabelow.

Step5:CalculateCommercialCostofEquity

NowthatwehavetheleveredbetaforBoeingscommercialdivision,wecancalculatethe
costofequityusingtheCapitalAssetPricingModel(CAPM).

Step6:CalculateWACCforcommercialdivision.

NowthatwehavethecostofequityforthecommercialdivisionofBoeingwecancalculate
theweightedaveragecostofcapitalfortheBoeingscommercialdivision.Inordertogetthe
WACCweneedtoknowthepercentageofcapitalthatwasfundedwithdebtandthe
percentageofcapitalthatwasfundedwithequity.Weknowthatourdebttoequityratiois
.525.WecanmanipulatethedebttoequityratiotofindtheBoeingscapitalstructure(how
muchtheyarefinancedwithdebtandhowmuchtheyarefinancedwithequity).Weshowyou
howtodothisbelow:

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11/17/2016

HowtofindtheWeightedAverageCostofCapital(WACC)ofaDivisionDefinition|Subjectmoney.com

NowthatwehaveourweightswecanfigureouttheWeightedAverageCostofCapital
(WACC)Boeingscommercialdivision.

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