I just feel confused about the question below, could anybody explain to me? Thanks!
For example, a company has 1 million market value’s outstanding equity and 1 million market value’s outstanding debt each with cost at 10% and 5%. The company plan to issue 0.5 million MV’s new equity and 1 million MV’s new debt with new cost at 12% and 7%. Assuming the tax rate=20%.
When calculating the company’s WACC, should I just consider the new capital only or both of the current and the new?
If the former, WACC=0.5/1.512%+1/1.57%80%=7.73%
If the latter, WACC=1.5/3.512%+2/3.5*7%*80%=8.34%
Could anybody tell me which one is correct? If neither, how to calculate the correct number? Thank you very much!
The target WACC is of importance. Once new equity and debt capital are determined then the former costs become meaningless. All else equal second expression
Some practitioner will take weighted average of the existing WACC and the target WACC. Their reasoning is the costs are observable hence they must be included. This is a wrong approach. The target costs are inclusive of the old capital and the proposed new.
Thank you for your help. To confirm that I don’t understand your answer wrong, is the second expression correct? That means, in calculating target WACC, for capital weight, the existing and the new should be considered, while for capital cost, just the new should be considered?
My confusion comes from a question below:
The answer is right. The approach is right. Your understanding is right.