The Beta for company B is required to estimate the WACC for Company B.

The Beta
is calculated using the following formula:
( , )
=
( )
Having calculated the Beta, the Beta is more than 1.0, which indicates that the
company B is riskier and also can generate more return relatively. After checked the
Beta amount provided by Eikon and other financial resources, for Company B, its
real Beta fluctuates around 0.3. The reason why this gap existed could be because
the sample size used is not appropriate or not large enough and also if a different
index was used, it would gives a different value of the Beta. To achieve a less error
estimation of the Beta, it is better to use the daily data derived from a shorter time
period, since the daily figures have less standard deviation and during short term,
the economic is less likely to experience a dramatically change (Daves, Ehrhardt &
Kunkel, 2000). As a result, it is appropriate to apply the Beta (0.3332) given by the
Financial Times for the company for further estimation.
To reach the final estimation of WACC, there is one element missing, which is the
cost of equity. Generally, the CAPM model is considered as the most common way to
find out the cost of equity. The formula is:
= + ( )

0.5309
0.5394

= (1 ) 0.15347

= /(1 ) 0.3272
Hence, = + ( ) = 0.6% + 0.3272(10.06% 0.6%) = 3.695%
Besides, the upper and lower bound are also calculated for the value of cost of
equity and saved for later using:

Best Estimates Upper Lower

Market Return 10.06% 26.2282% -6.1082%

Equity Premium 9.46% 25.6282% -6.7028%

Cost of Equity 3.695% 8.9855% -1.593%

Moving to the calculation of Weighted Average Cost of Capital (WACC) using the
following formula

= (1 ) + = 2.92%
+ +

Debt for company A (D) 4,027m

 Equity for company A (E) 3557.81m

Cost of Debt for company A ( ) 2.96%

Tax Rate (T) 24%

Cost of Equity ( ) 3.695%
To test for the upper and lower limit, changing the value of Cost of equity in the
WACC formula to obtains the value range of the WACC. Below are the results of the
Upper and lower limit of WACC:

Best Estimate Upper Lower

Equity Premium 9.46% 25.6282% -6.7028%

Cost of Equity 3.695% 8.9855% -1.593%

WACC 2.92% 4.3346% -0.628%

So the value of WACC in this model is between -0.628% to 4.336%. Logically, it may
seems that the WACC should not be negative since the negative figure could mean
that the company will not receive any return on this project and will make a loss,
hence it would be a bad decision to invest in this project. From a mathematics
perspective, the negative figure for the market return during the economic recession

would directly change the component of + into a negative value, as a result,
produces a negative WACC result.
The WACC result can be affected by many variables such as the tax rate, cost of
debt, cost of equity or the gearing ratio. To apply a sensitivity analysis, the debt level
is changed while keeping other variable unchanged1 or constant in order to test how
the results of the WACC changes in relationship to a change in the level of debt or to
test the sensitivity of WACC to Debt.
Debt (m) Gearing WACC
0 0 0.03695
500 0.1232 0.03517
2,000 0.3599 0.03175
4,027 0.5309 0.02926
7,000 0.6630 0.02737
15,000 0.8083 0.02527

1The cost of debt is also remains at the level of 2.96% during the sensitivity test. Only the value of debt changed which
would also change the gearing ratio.
 Relationship between WACC and Debt
0.04

0.035

0.03
WACC

0.025

0.02

0.015

0.01
0 2000 4000 6000 8000 10000 12000 14000 16000
Debt(m)

From the above results, it can be seen that the WACC decreases as the gearing
ratio increasing. This could be because the cost of debt is cheaper than equity,
hence as debt increase, the lower is the WACC provided everything else remains
equal. However, the values do not truly reflect realistic situation and this analysis
could be inadequate because when the company increases its debt level to a certain
high point, where its becomes in a higher risk bracket, which will mean the cost of
debt will have to go up in order to compensate the high risk and this would result in
the WACC going up. Although the WACC does not go up in the graph, one thing is
apparent, which is the level by which WACC goes down is smaller as the debt
increases in proportion. But it is very difficult to test the sensitivity of WACC under
the real financial world framework by just changing one variable, as in the real world,
a change in one variable will effect the second variable. According to the Modigliani
and Miller (1958), under a perfectly capital market, the debt policy doesnt matter
since its real asset determines the true value of a firm. Whats more, the tax rate,
financial distress would affect the determination of optimal capital structure.
The tax rate in this case also takes the form of average among ten years annual
data. Using the same 95% confidence interval to figure out the upper and lower limit
of tax rate and test again for the WACC. The results as follow:
Best Estimate Upper Limit Lower Limit
Tax Rate 24% 52.33% -4.33%
WACC 0.02926 0.03365 0.02486
The interval for WACC is between 0.02468 and 0.03365, which still lies between the
original interval from -0.628% to 4.336%. The reason why the interval is wide is that
the estimation of cost of equity is not precise that would produces a significant effect
on the final results. Under an ideal premise, with all other elements keeping constant
and only increase the debt level, the value of WACC would decrease correspond.
By changing some estimates or assumptions in the sensitivity analysis, it is able to
see what impacts the change variables would bring to make financial decisions. The
application of sensitivity analysis could point out which variables the NPV sensitive to
and find the reason why a project should be reject (Zhamoida&Matsiuk, 2011).
For all the sensitivity analysis had done before, the conclusion that the value of
WACC is from -0.628% to 4.336% still holds. But when using WACC as an indicator
to determine the NPV of the project and decide whether this project should be
undertaken, the negative figure reveals that there is a high possibility that this project
will make a loss. For any positive value less than 4.336%, it would be safe to
assume that this is a good project to take on.

Reference
Davesl, P., Ehrhardt, M., and Kunkel,R. (2000) Estimating Systematic Risk: The
Choice of Return Interval and Estimation Period. Journal of Financial and Strategic
Decisions. Vol. 13 No. 1.

Modigliani, F., Miller, M. (1958) The Cost of Capital, Corporation Finance and the
Theory of Investment. American Economic Review. 48 (3), pp. 261297.

Zhamoida,O.A. and Matsiuk, M.S.(2011) Sensitivity Analysis in Capital Budgeting.

Economic Herald of the Donbas. No.4 (26), pp. 132-136
Appendix
Exchange Date Close-Market Rm Close- JDW Rjdw
31-Dec-15 17,429.82 8.36% 748.5 -8.72%
31-Dec-14 16,085.44 0.94% 820 7.68%
31-Dec-13 15,935.35 28.77% 761.5 42.87%
31-Dec-12 12,374.97 22.49% 533 28.37%
31-Dec-11 10,102.90 -12.60% 415.2 -7.73%
31-Dec-10 11,558.80 24.20% 450 5.88%
31-Dec-09 9,306.89 46.32% 425 36.66%
31-Dec-08 6,360.85 -40.32% 311 -15.83%
31-Dec-07 10,657.80 -4.65% 369.5 -46.87%
31-Dec-06 11,177.80 27.10% 695.5 109.80%
COV 0.067165875
VAR 0.062930292
Beta 1.067305954