# 2009 Exam - WACC Calculation

Hi All, Can someone explain me the calculation of WACC problem? I am having a hard time in understanding the concept and calculation associated with WACC for pension. I am like 98% sure that it won’t be in 2010 exam but you never know. Thanks, PD

I hope you are right because I am punting it

This WACC calculation accounts for the pension assets… GAAP does not require the companies to report their pension assets and pension liabilities on their Balance Sheets (as long as they footnote them)… but when we calculate the Company’s cost of equity, we must account for them… WACC = CoE = Rf + beta*RP We only need to calculate beta adjusted for pension assets to calculate the true WACC. First, I would build the balance sheet. Assets v. Lib+Eq Assets:___________________Lib: 1,000 (original op. assets)____500 (original debt) 800 (pension assets)________800 (Pension liab) _________________________500 (original equty) -------------------------------______----------------------------- 1,800_____________________1,800 Beta(500 orig equity) = 2 Beat(any debt) = 0 Beta(equity in pension assets) = 1 Beta(pension assets) = 1*60% + 0*40% = 0.6 Betas: Assets:__________________Lib: x (original op. assets)_______0 (original debt) 0.6 (pension assets)________0 (Pension liab) ________________________2 (original equty) ------------------------------- ----------------------------- 0.56____________________ =0*500/1800 + 0*800/1800 + 2*500/1800 = 0.56 x*1000/1800 + 0.6*800/1800 = 0.56 solve for x = 0.52 And finally, plug this number into your WACC formula… *sorry, had to add some lines to align vertically…

Why is WACC calculated using only the CAPM Cost of Equity?

mib20 Wrote: ------------------------------------------------------- > Why is WACC calculated using only the CAPM Cost of > Equity? Good question ! CFAI never explain !

If this question comes up in the exam, and you’re doing your exam in Sydney, I’ll be the guy jabbing his pencil into his eye

newsuper Wrote: ------------------------------------------------------- > If this question comes up in the exam, and you’re > doing your exam in Sydney, I’ll be the guy jabbing > his pencil into his eye It’s better to ask CFAI : why ?

mib20 Wrote: ------------------------------------------------------- > Why is WACC calculated using only the CAPM Cost of > Equity? If you read the CFAI material, the author ponders how do you get estimates of your WACC? “If you are a publicly traded company, you can typically observe the historical movement of your share prices, and then estimate the beta of the share returns. When you do this, you are really assuming that the historical volatility of the stock is a reliable proxy for its risk – and, in this sense beta is a wholly market-based measure of risk.” It is difficult because LI & LII you were drilled to remember their definition of WACC, but you need to set that aside and understand there are alternate methods of calculating it and that is what the author does.

correction: GAAP requires report of pension and requires footnote. GAAP actually requires reporting a net position for each plan. So assets and liab are netted and reported as 1 number. If assets > liab, the net is positive and shows up as assets. This is called over-funded. However, if you gross them up, the numbers are quite big. Curriculum says roughly 2x of operating assets. This causes big change in WACC. I am 101% sure WACC will not show up this year. Why? Well, I did some community work early this year, with some help from my college professor. I wrote an email to CFAI and “explained” US GAAP to them. They replied that they would think of it. I interpret before they finish thinking, they would not put it back in again. The GAAP is not that clean. It is not just assets and liabilities. Pension, thanks to a new accounting standard FAS 158, also shows up in equity section. In the past 2 years, due to the dramatic change in rates, the equity portion is getting bigger and bigger. We cannot simply gross up assets and liab and leave the portion parked in equity alone. That’s all I know for accounting. Did I say 101%? Discount my word using your own judgement. Certainly don’t blame me if small possibility happens to you. (It happens to me 102%.) kurmanal Wrote: ------------------------------------------------------- > This WACC calculation accounts for the pension > assets… GAAP does not require the companies to > report their pension assets and pension > liabilities on their Balance Sheets (as long as > they footnote them)… but when we calculate the

I agree with you, Boris, that the companies are required to report the net funded status of their pension (it could be on the asset side or liability side…) So, I stand corrected! However, i was more referring to the gross amounts of the assets and liabilities… the companies are only required to footnote those numbers (which you rightfully noted)…

newsuper Wrote: ------------------------------------------------------- > If this question comes up in the exam, and you’re > doing your exam in Sydney, I’ll be the guy jabbing > his pencil into his eye into whose eye? mine? thank Jesus I will be taking it in LA!

Also, why was only the operating asset beta used to calculate the CAPM, rather than the entire blended pension/op asset beta?

I believe it’s because we are try to compute WACC to accept or reject business projects (directly related to operations of the business)…

mib20 Wrote: ------------------------------------------------------- > Also, why was only the operating asset beta used > to calculate the CAPM, rather than the entire > blended pension/op asset beta? I think this is the method I took. First calculated WACC for the company, then calculated WACC for pension, then blended them together. My value was about 10.5%

Read this section from the book… Page 483-484. Once i read it, i feel lot confident

I was looking hard for the interest rate on the debt while I was doing the exam. How come debt is not incoporated into WACC? I really have a hard time trying to understand the logic or the concept.