Question

You want to estimate the Weighted Average Cost of Capital (WACC) for Costco Corp. The company’s tax rate is 21% and it has the equity beta of 0.9. Its debt value is $14,727 million and the equity market value is $138,394 million. Its interest expense is $150 million. Assume that the risk-free rate is 3% and the market return is 10%. Based on the information, compute the WACC for Costco.

Answer 1

Ans : Weighted Average Cost of Capital (WACC)

WACC = E / V * Re  + D / V * Rd

where,

E = Value of Equit
D = Value of Debt
V = Value of the Firm
Re= Return on Equity
Rd = Return on Debt

Below figures are in millions

WACC = {138,394 / 153,121 (Note 1) * 9.3 % (Note 2) } + {14,727 / 153,121 (Note 1) * 0.80464 % (Note 3) }

= ( 0.90382 * 9.3 % ) + ( 0.096179 * 0.80464% )

= 8.4055 % + 0.07739 %

= 8.4829 %

Note 1 : Value of the Firm = Value of Equity + Value of Debt
= $ 138,394 + $ 14, 727
= $ 153,121

Note 2 : Return on Equity

Re = Risk Free Rate + Beta * ( Market Return - Risk Free Rate )
= 3% + 0.9 * ( 10% - 3% )
= 3% + 0.9 * ( 7% )
= 3% + 6.3%
= 9.3%

Note 3 : Return on Debt

Interest Expense after Tax = Interest Expense - Tax Rate
= 150 M - 21%
= $ 118.5 M


Rd = ( Interest Expense after Tax / Value of Debt ) * 100
= ( 118.5 / 14,727 ) * 100
= 0.80464 %