WACC - beta
Beta is a measure of how a stock moves relative to an index, where a
value of 1.0 moves with the index, less than one moves less than the
index (less volatility) and greater than 1.0 moves more than the index
(more volatility). The price volatility is analogous to the
market's assessment of the short term risk in your business.
Most financial services, including Standard
and Poor's or Value Line,
"The boss" knew her firm's beta was 1.23 and her industry's was 1.15.
That means the market views her firm as a bit more aggressive but offering better returns for the additional risk.
Her firm's Cost of Equity (Ke)
8.87% = 4.89% (risk free rate of return) + (1.23 (stock beta)
x 3.27% (market risk premium))
The firm's weighted average cost of capital (often abbreviated as Kc)
The firm's proportions of equity to debt is 71% to 29%, so
8.07% = (.71 X 8.87% cost for equity) + (.29
X 6.12% cost of debt)
"The boss" thought that the firm WACC is about 2% below the
rate we've been using in our hurdle rate for our
cost to raise capital and in today's stock
market, investors are expecting a lower return (3.2%) over the historical
expectation of 7%. Prof. Damadron's data indicates in January 2003, for
all business sectors, the risk premium ranged from 0.7% (precious metals)
"The boss" thought: this is market driven, why didn't we adjust
our hurdle rate, and in early 2003, this "market" is very cautious.
WACC - Risk Premium