Capital Structure and Risk

WACC

Column Table Displaying Companies and their WACC

Company

Brief Description

WACC

Bank of America (BAC)

Bank of America is deemed to be one of the world's largest financial institutions and among the best wealth management companies in the world. According to the company's annual report, its banking as well as nonbanking divisions provide and supply a wide-ranging set of financial product and services through 5 primary business segments. These are categorized as Global Wealth and Investment Management, Consumer and Business Banking, Global Banking, Consumer Real Estate Services and Global Markets (Bank of America Corporation, 2014).

Qualcomm Incorporated (QCOM)

Qualcomm Inc. has come to be one of the major players in mobile technology and innovation. The company concentrates in the areas of creating mobile semiconductor chips, 3G, 4G as well as Code Division Multiple Access (CDMA). In the past of years, Qualcomm Inc. has been a prevailing force in the market (Qualcomm, 2016).

11.7%

Staples Inc. (SPLS)

Staples, Inc. is one of the largest suppliers of office products and services in the United States. The company retails office products, services and commercial solutions from end to end multiple distribution channels, comprising office supply stores, direct mail by means of B-2-B e-commerce and sales workforces that appeal to medium and large companies (Hoovers, 2016).

12.45%

Starbucks (SBUX)

Starbucks Corporation is considered to be one of the biggest roaster, marketer as well as retailer of specialty coffer all over the world. The company offers a variety of consumer products including coffee as well as tea, readymade beverages and ice cream. Aside from its main Starbucks brand, the company also undertakes its marketing operations through other brands such as Tazo, Teavana, Evolution Fresh, Seattle's Best Coffee and many others (Yahoo Finance, 2016).

6.5%

Coca-Cola Company (KO)

Coca-Cola company is the most prevalent and highest retailing soft drink in the world and the brand is one of the most acknowledged ones. The company retails different beverages such as sodas, water and juices. These include Sprite, Fanta, Diet Coke, Dasani, Minute Maid, Powerade, Fresca and so many more.

6.85%

Why do firms need to know this value?

Weighted average cost of capital (WACC) can be described as the average return- rate that a firm anticipates to pay off to all its various stockholders. The weights happen to be the element of each funding source in the country's target capital framework, which is the combination of debt and equity that a firm employs to supply and pay for its operations. It is imperative for companies to make their decisions on investment and assess projects with equivalent and inequivalent risks. To calculate significant metrics such as economic value added and net present values necessitates WACC. From the perspective of a company, the WACC can be ascertained as the amalgamated cost of company that the company has to recompense for using the shareholders' capital and debtholders' capital. Therefore, companies need to know this weighted average cost of capital as it delineates the minimum rate of return that a company ought to earn in order to create value for the investors (eFinance Management, 2016).

How is the weighted average cost of capital used to make decisions?

Through appraisal of the projects, companies extensively utilize the weighted average cost of capital for undertaking investment decision-making. This is done in two distinctive ways.

The first approach is the evaluation of projects that have the similar risk. In particular, when the new projects are of the same risk, such as prevailing projects of the firm, the WACC is a fitting benchmark and point of reference for making decisions on whether such projects ought to be accepted or rejected. For instance, an apparel manufacturing company aspires to expand its business operations to new expanses, that is, institute a new facility for the similar kind of apparel in a different site. A firm that is entering new projects in the same areas operation can realistically make assumptions of the same risk and utilize WACC as a measure to decide whether it should go on with a project or not (eFinance Management, 2016).

The second approach is through the evaluation of projects that have varying and dissimilar risks. It is imperative to note that WACC is a fitting and suitable measure to be utilized to assess a project on the condition that two fundamental assumptions are true. These two suppositions encompass similar capital structure and similar risk. Such a quandary can be resolved by deploying WACC. WACC can be utilized with particular modification with regard to the risk and target capital structure. In particular, risk-adjusted WACC is a solution to evading any issues that come about from WACC assumptions (eFinance Management, 2016).

What are each of the components of the weighted average cost of capital and how are each of these components estimated?

The WACC is calculated using the following formula

WACC = Weight of Equity x Cost of Equity + Weight of Debt x Cost of Debt

i. Cost of debt

Debt as a component of capital can be issued at a discount, at par or at a premium. More so, it may be perpetual or convertible. The debt issued at par is computed using the formula Kd = (1- T) R. where Kd is the cost of debt, T is the tax rate and R. is the debenture rate. On the other hand, debt that is issued at a discount or at a premium is calculated using the formula Kd = I (1-T) NP with I being the yearly interest rate and NP being the net proceeds of the debentures.

ii. The cost of equity is considered to be the return that a company ideally and hypothetically recompenses its equity investors such as stakeholders as a compensation for the risk they take up as they invest in the company.