Alan Kring Productions in association with Emergent Light Studio presents the Illinois
State Collegiate Compendium, Academic Lecture in Business and Economics.
This is Business Finance, FIL 240 for autumn semester 2023.
Today, the cost of capital.
I'm going to go through the markets and I have a guest speaker, an expert on market
conditions who's going to speak for a few minutes and that'll help you help clarify
investments that you may want to be thinking about making and then after that we'll go
into the lecture.
This is a mathy kind of lecture but this is where you learn how to be really grateful
for Excel because it can make the math a lot easier.
Now today I'll go through just the first round of it and then we'll come back and do it again
on Wednesday to get it reinforced and I'll build the templates with you on Wednesday
so that you see each piece of it and it kind of makes more sense to you the equations still.
But first I'll look at the numbers and then a guest speaker.
We have a bold day here but it's kind of an odd bold day because you have the Dow up $511
but that's pretty meaningless.
It's the meaningful part is 1.58%.
Oddly though then the S&P is up only 1.20% and the NASDAQ is up only 1.16%.
So this is sort of a reverse of what you usually see and it's all because there's some positive
news going on but it seems like the positive news is more positive the bigger the companies
and so hence why the Dow is up more strongly than the NASDAQ and the S&P 500 or the NASDAQ.
Well that's okay.
I mean it's a good day.
Happiness is everywhere.
So we have that going on and also notice that the rise was mostly in the morning.
It wasn't dramatic.
It was just a nice smooth roll upward and then it sort of leveled off.
There was good news that was seeping into the market into the midday and then from there
there wasn't any more bad news or good news so it kind of leveled off.
Now notice crude.
You remember my trading range, 82 to 88.
Well now we've gotten toward the bottom of that trading range on oil.
As I had said back when oil popped above 90 a barrel, well I wasn't worried about that.
I thought it would come back into its range but now we're down there at 82.50 on the light
sweet Brent and that's a benchmark.
Well obviously that's good news because costs of gasoline may ease up a little more.
It's not going to go down a lot more but we may see a little bit more easing in the price
of gasoline and all that talk a couple months ago, well there was this Arab state and this
other state that were, the Russia were in this deal, they were going to cut oil supply,
oil production, that would drive the price through the roof and I said don't worry about
it, well here you go.
Those kinds of agreements like that don't last at all and so we're back down here on
crude oil.
Another thing that's going on is that it appears that the war premium has slid away completely.
The concerns that there is a, that this fight between one of the nations of the Middle East
and a non-state actor in the same region is going to expand, that doesn't seem to be what
the market is seeing as possible, as probable now.
Hence why another cause for oil prices to go up isn't there anymore.
Moving on, the gold bugs, they've gotten above the $2,000 per ounce resistance line.
They're convinced that the apocalypse is coming, I don't think they're going to be too happy
that it doesn't but there you are.
Ten-year bond, yield is up which means the price is down.
So that would mean that investors are getting out of bonds and since stocks are going up,
they're moving that money to equities.
Now if I look at the SP500 volume for the day, it's about where it has been for a couple
of weeks.
It's not nearly the average, close to the average daily volume over the past year but
it has made some move upward.
So there's cautious movement back into the market.
The idea that there's going to be this big recession coming and you still see it now,
it's just not the numbers aren't telling us this.
The GDP was strong, we're easing the inflation out although it doesn't look like it too much
yet but we're getting there.
Okay now, well the euro and the pound and the yen, now they're all appreciating against
the dollar.
So the dollar has weakened, depreciated against all three of those currencies.
Nothing spectacular.
What it looks like is that all these currencies are in a trading range right now.
They're just bouncing around.
For the euro it would be bouncing around 105 to 107 to the dollar and the same is happening
with the other currencies.
Nothing scary there at all.
Now over here on the other side of the world, last night the Japanese yen, the Nikkei, Tokyo
exchange, the Nikkei 225 dropped like a rock right at the opening but then it just drifted.
So something spooked them before the trading began last night in Tokyo.
But then from there it just kind of flowed.
There was a little bit of a bull rally there toward the last, in the last hour and a half,
two hours but nothing big.
And London started out with a big pop and then it floated until after the midday and
it eased back up a little, some.
It backed off and then it just kind of floated toward the end.
So what does all this mean?
Well there's not a whole lot to worry.
The global markets don't seem to be all that concerned about some massive recession or
some global World War III, which is good news for you folks.
That means that you'll probably go out into a pretty strong economy for internships and
jobs come this summer or next fall.
So there you are.
That's good news.
Now looking at a couple of companies, just for a little bit of fun, the first one I'd
look at is, well, auto companies.
Ford.
Ford barely, it just died.
Almost 2% down today.
It is near the bottom of its 52 week trading range right now, which matter of fact, no,
it's a little tiny bit above.
It's bottom over the whole year.
Now if I were to look at a year chart, look at Ford, see that intermediate declining tops?
Do you see how the tops are declining?
And the bottoms of the troughs are declining too.
A technician, a technical analyst, one of the elves would say, oh, this is nasty.
That's a bad news.
Ford is sliding and it's going to keep sliding for a while.
So we'll take that for what it's worth.
If we were to look over here at General Motors, well, it was up, but notice something interesting.
General Motors was up less than the S&P 500.
It was up only about a little less than half of what the S&P 500 did.
And yet GM has a beta of nearly 1.5.
So it should magnify the market.
And today, it was not nearly as strong as the market itself.
So that kind of is a little bit worrisome there.
And then a little laugh fest here, Tesla.
Tesla is now below 200 a share.
You're finally beginning to see the analysts coming out with the truth of the matter.
There was a report from one reputable analyst who was saying the banks and the investment
banks are just sick of it.
But they can't get out.
Because if they got out, they would crash themselves on the way out.
And so essentially, this is the miserable little child that they thought was going to
be so much, and it's just fizzling away.
Car sales were hugely disappointing.
Their great ideas that he of the cloven hoof has put forward have seemed to be nothing
but other dreams of his.
This is not a good sign.
It skidded almost 5% today in a market that was bullish today.
And so that gives you a caution.
Don't jump into stocks just because there is a fad going on with them, or you like the
guy for his toughness and all that bull.
You look at the numbers.
You look at the market.
You look at the competitive landscape, the technologies, and it just wasn't there.
And his history of fiascos and the ones coming after it, like Twitter.
But there is a bull market going on.
And I do want to give you some...
I would say this is a bullish investor, bullish expert, in fact.
I'm going to go out and get him so that you can have a chance to hear him.
Hi, I'm a bull, and I'm here to talk to you about bull markets.
Bull markets are where it's at.
The market is going to go up permanently, and I should know because I'm a bull.
And don't believe anyone who tells you differently.
You hear these investors talking about bear markets, these experts talking about bear
markets.
I'm going to tell you that there is no such thing as a bear.
Bears do not exist.
They are a myth.
I have never heard of a bear in my life.
Mo?
No, no, no, leave me alone.
Get away.
No, it's a bear market.
Help, no.
Mo, Mo.
Mo.
Component cost of capital.
Today's lecture is on the cost of capital.
What happens in this classroom stays in this classroom.
In accounting, numbers, dollars are everything.
One of the biggest distinctions between finance and accounting is that we really don't care
about the dollar values.
What we care about are percentages.
Cost to an accountant is in dollars.
Cost to us in finance is in percentages.
And so when we talk about the cost of capital, each one of these component costs is going
to be a percentage.
And so it seems a little odd to talk about the cost as a percentage, but you've already
seen me doing it on a number of occasions.
You talk about on a financial statement, in the income statement, you have your revenues
minus your cost of goods sold is your gross income or gross profit.
We don't care about that.
We care about the gross margin, the percentage.
All of those ratios were percentages.
Well, a few of them were multiples, but we didn't talk about dollars at all.
And in fact, you've seen the first of that when I talked about debt.
PVZ 5.0% 2038, there's a cost, the coupon.
Now I can turn that into, that's a coupon rate.
Now I can turn that into dollars.
You would take the face value, which is always 1,000, times 5.5%, 5.0%, and you would get
$55.
That is the dollar amount.
We don't care about that.
You say, well, you better care about the cost at some point in dollars.
Well, we do that, but mostly we just let the accountants do that.
But that's the cost of debt.
5.50%.
Now that's a preliminary.
We have to dig a little deeper, because that 5.50% is actually old history.
This bond, 10-, 20-, or 30-year bond, it was issued in 2028, well, no, it wouldn't have
been in 2028.
That cost right there is old news.
It really doesn't mean much of anything other than that's what we have to pay.
But in terms of what is the current cost, we'd have to do some more work on that.
So anyway, the components of the overall cost of capital.
There's the cost of debt.
And then there's these two equity costs, the cost of preferred stock and the cost of common
stock.
Now there's one thing I should point out in here, and I'm not going to do it in this lecture.
I'll do it in this one.
There's actually a different cost to your existing common and to new common.
The cost of new common is kind of high.
Cost of, well, okay.
Usually debt is cheaper than equity, usually.
And you'll see the racking of the numbers up like this.
Now the one that, debt is pretty easy.
It's just a really simple formula.
Preferred is easy.
It's just a simple formula.
The one that can kind of get you is this common, because we can't use the same formula every
time.
It depends on the company, what type of company it is.
But the good news is that we've got Excel, which makes it a lot easier whichever way
you want to do it.
You've got a way to do it in Excel without tripping over the numbers too much.
But okay.
See this number right here?
The problem is that the coupon is historical.
It's old.
This coupon could have been established as a required rate of return back in 2018 before
interest rates went bananas upward, or 2008.
So we need a more current number than the coupon.
And we have one.
It's pretty easy.
We use the yield to maturity, the YTM, because that's what the market is currently saying
the company should be paying.
Well the yield to maturity right now, in actual practical terms, you'll see bonds that have
coupons like 5.50%, but their yield to maturity is up there like 7%, 7.5% now, because interest
rates have risen.
So we've got to look at what the current market conditions are.
So instead of using the coupon rate, we will usually use the yield to maturity.
Now the way the homework used to go is they said just use the coupon rate.
But now in your homework they will say, okay, the yield to maturity is.
Or you could calculate the yield to maturity with that bond calculation sheet that I gave
you, as long as you know the price of the debt and the term.
But anyway, so there's one other factor involved with the cost of debt.
Interest expense is deducted before the company calculates its taxes.
So interest expense represents a tax shield.
So in other words, the after-tax cost of debt would be the before-tax cost of debt times
one minus the company's tax rate.
Now remember that this will be the yield to maturity, not the coupon.
I mean if you don't have the yield to maturity, you can use the coupon, but you've just got
to recognize that you're probably going to be off.
So for example, in this suppose that the current yield to maturity on PVZ debt is 6.15%.
So in this case, the after-tax cost of debt, R with a superscript AT for after-tax and
a subscript D would be 6.15%, the yield to maturity, times one minus the marginal tax
rate, which is currently 21%.
And I'm going to do that on the calculator the next time I'll be using Excel to do it.
So I would take 6.15 times, open parenthesis, one minus.21, close the parenthesis, and
now I get an after-tax cost of debt of 4.8585.
That's the cost of debt.
And that's the formula for getting it.
Just have these in your notes and on your note card, and also we'll have a model in
Excel.
I'll build the model in Excel with you.
We'll do it all together on Wednesday.
I'll even show you some new tricks I'll bet you've never seen before in Excel that make
some kinds of calculations super easy.
Okay, cost of capital, debt is finished.
Now the cost of preferred stock is also pretty darn sweet.
And this is a nasty trick, and you'll see me do it two times in this lecture.
Okay, preferred.
I showed you a formula for price right now of preferred stock, and I'll put PRF down
here, price now of preferred stock is going to be equal, this was a formula I showed you
before, the dividend, the constant dividend divided by the required rate of return.
In other words, what investors want that to be paying as far as the percentage return.
That was the formula I gave you last week, or two weeks ago.
Okay.
2.85% preferred par value, $75 per share, is currently priced
at $38.25 per share.
Now let's go back over to this formula that I gave you a couple weeks ago, and let me
turn it around so that R preferred is equal to the dividend divided by the price, the
current price of the preferred.
I just multiplied R on both sides and divided by P0 on both sides.
So now I have a formula for calculating the cost of preferred.
I can do it.
So the cost of preferred is going to be the dividend.
So the dividend is just 2.85% of times $75.
So the dividend is going to be.025.0285 times 75 divided by $38.25.
5.59%.
Oops.
Did I do that right?
Let me get the dividend first.
I apologize for that.
I should have just shown you.
I did the whole formula.
Let me just get the dividend first real fast,.0285 times $75.
So the dividend is $2.13.75.
And then I'll take the $2.13.75 divided by the current price, which is $38.25.
I did the whole formula.
And then that's how you get the, well, let's divide it by $38.25.
Get that number back again.
5.59%.
That's the cost of preferred stock.
So now I've got the formula for the cost of preferred.
Just take the dividend divided by the current price of the preferred.
So there's another one.
Done.
The last one is the pain.
Cost of common.
Start with the one that's the easiest.
An older company that has a stable dividend growth rate.
I gave you the formula for common stock.
By the way, the book says the cost of retained earnings.
That's not really a good way to put it, but common stock.
Now if the company has a constant growth rate of dividends, we have a formula for the price.
Remember the price right now, and we'll use an S for common stock, would be the dividend
in period one over the cost of common minus the growth rate.
Where D1 is the current dividend grown one period.
That's the formula I gave you last week.
It applies only to companies that have a constant growth in the dividends.
Older companies, companies that are stable.
Now I'm going to do some cross multiplication here.
You don't need to write this down.
I'm just showing you how I get.
I'm going to tease out the R sub S, the cost of common stock.
I'm going to cross multiply so I get R sub S minus G equals D1 over P0 of the stock.
I just multiply both sides by this and divide both sides by the price.
And so finally, the cost of the common stock would be the dividend in period one divided
by P0 sub S plus, I'm going to add the growth rate to both sides.
That's all I did in that step.
So now I have a formula for calculating the cost of common stock.
But it applies only if the company has a constant growth rate of dividends.
So it doesn't apply to all companies.
But it's a place to start.
So on this one, our first formula is R sub, the cost of common stock is the dividend in
period one divided by the current price of the stock plus the growth rate.
PVZ common just paid a $2.50 per share dividend.
That is expected to grow at a constant rate of 3% for the foreseeable
future.
The current price of PVZ common is $20.30 per share.
Let's write that down.
And now I'm going to use a formula to get it.
Okay.
First thing I'm going to need is D1.
D1 is the current dividend times one plus the growth rate.
So that would be the current dividend, which is $2.50 times one plus.03.
So what did I say, $2.50 times 1.03 equals 2.575.
$2.57.
So the cost of common is going to be 2.575 over the current price, which is $20.30.
And then plus out here.
Make sure you keep that plus.03 separated.
So I'm going to take the 2.575 divided by the current price, $20.30, and then I'm going
to add the.03.
15.68%.
So there you go.
That's how you do it.
Just an example.
And I'll do this again on Wednesday.
I'm not going to leave you hanging with just one example, but we will use Excel to accelerate
this process.
Where am I?
Okay.
Here's the problem.
Not all companies are old and have that constant growth rate.
However, this model for old companies is informative.
It gives us an insight, a couple of insights.
Notice that the cost of equity, and therefore the overall cost of capital, goes up as the
price of a stock goes down.
That is something that companies kind of don't pay attention to.
Is that over a long period of time, if their stock price is going down, the cost of equity
is going up.
There were a couple of examples when I was a consultant where at a meeting I would say
our stock price is going down.
It's going to the toilet.
And I would get this response like, well, yeah, so it doesn't affect us.
What's that going to do?
The first thing is, well, if you go out there and try to raise more equity capital, you're
selling the stock at a low price.
So obviously right there you've got a problem.
The second problem is a little bit subtler.
The second issue.
No, but let me point that out.
That stock price going down is like a fever.
You don't, a low grade fever.
A company doesn't even notice it at first, but it has a cumulative effect on the company's
operations because the cost of one of its components, component cost of capital, is
rising.
Therefore, the entire capital structure of the company is becoming more costly.
And that's a problem.
And it hurts over a period of time.
That's why when you see a Tesla beginning to slide, that's not just, ah, well, it's
going to be a bad, yeah, stock is going down in price.
No, that could be an indicator of something more darker.
It's like Ford.
When I see Ford heading for its 52 week low, and it doesn't seem to want to stop because
both the tops and the bottoms are skidding together.
Well that's an issue.
That's something that is telling me Ford might be in more trouble than we think because it's,
yeah, the stock price is going down.
Boo hoo.
But that tells us that there's a deeper, the whole capital structure is becoming cheap,
more and more expensive over time.
There's another one there.
See that growth, that plus G?
In other words, as a company's growth rate increases, its cost of equity capital increases
as well.
Now what that tells us, find another marker here if I can.
What that tells us is that there is a, there we go, this is the marker.
That tells us that growth actually costs.
In fact, I don't do it directly in this class but I will tell you about it.
In my, another class I'm teaching, a higher level finance class, it actually is the case
that the, there is a growth rate called the sustainable maximum.
If a company stays above that growth rate, the company will actually die.
We have a number of examples of just that problem happening with companies.
They actually bit the dust because their growth rate was unsustainable.
That seems like that's almost like, that's counterintuitive but it actually is the case.
If that growth rate gets too high, the cost of equity capital gets so bad that the overall
cost of capital breaks the company.
It breaks the company's back.
Like I said, we have plenty of examples of that.
We've seen it in practice.
Just because a company is, yeah, grow, grow, grow, boy is this incredible.
Year after year this growth is incredible.
You don't want that.
Now one or two years of rapid growth, yeah, that's great but it has to slow down or it's
going to burn itself out.
And so that formula, that model there gives us a window into why growth isn't always just
year after year after year of accelerating growth.
Can't do it.
The company will die.
Think about this.
You sir are my son.
When you were a toddler, hi daddy.
And then one day you come in and you're the incredible bulk.
Oh my God.
Whoa, whoa, what the hey.
You have grown too fast.
Your bones can't keep up.
You walk through the front door and you crack your head on the ceiling of the top of the
door.
That is the same process.
Growth going on too fast weakens the company.
That's why there is such a thing as maximum sustainable growth rate.
It's a formula.
I just showed it last week in another class and then I showed some examples of companies.
This company died.
Well, let's look at its growth rate.
Well, I'll be darned.
Let's calculate the maximum sustainable growth rate.
It was above maximum sustainable growth rate for three, four, five years.
No surprise that it died.
Okay, so enough of that.
What do we use though if you don't have a company that is old, it's got a constant growth
rate?
Still trying to find another.
Let me see if this one works.
Okay, that's what I'll do.
What happens if we have a company that is an old growth, constant growth rate?
Okay, do we have anything else we can do?
Well, yeah, I showed you one.
You can use the capital asset pricing model.
The expected return to a stock is going to be the risk free rate plus the beta of the
stock times the expected return to the market portfolio minus the risk free rate.
This marker isn't working either too well.
Okay, yeah, you can use it.
I mean, it's there.
It's a solid model.
We usually use it to calculate investments, the expected return to a stock that you've
bought, but it's perfectly fine to use for calculating the cost of equity capital because
at least theoretically, the expected return to the investors would be the expected cost
to the company of the stock.
They should be about the same.
So the cap M can be used.
Our results are mixed, so using cap M. Now, if you were to use the, you've got an old
company.
Okay, let's use this constant dividend growth model to get the cost of equity, and then
let's use the cap M to get the cost of equity.
Usually they're pretty close, but sometimes they are spectacularly different.
And there are theories of why this happens.
It's not normal, but it does happen.
So you have to kind of take your choice.
One thing that is done oftentimes in older companies where you can use a constant growth
rate dividend model, but you can also use a cap M, there's a beta, you take the average
of the two numbers.
This one came out with a cost.
Did I throw it away?
It's a rate.
Suppose that the cap M came out with 16.27.
You'd probably take the average of those two.
However, there are companies that don't have a beta, and you can always get a beta from
a comparable and take a stab at it that way.
But there's a third way too.
It's called the bond yield plus equity premium.
I'll just throw an example at you.
Suppose that PVZ is in an industry that has
an average cost of equity of 20, let's say 24.60 percent.
That's the industry average.
So yeah, well we could use that directly, we could say, well let's use that for PVZ.
Probably we can do a little better.
The industry average for bond yields is, let's say, the average
current industry for bond yields is, let's say, 6.70 percent.
Now here's the theory that the cost of equity is the bond yield of the
company plus an equity risk premium.
In other words, we are postulating that the cost of equity is the cost of debt plus an
extra kicker because it's equity, so it's riskier.
So what we are using here is we're saying that in the industry 4.60 percent is going
to be equal to the bond yield to maturity, the average bond yield to maturity plus an
industry equity premium.
Now if I work that around, and of course I don't use simple numbers, the industry is
telling us, and of course I exited the calculator, is telling us that 24.60 percent minus 6.70
percent is the industry equity premium, 17.9 percent.
17.90 percent is the industry's equity premium.
So if I can get the yield to maturity of PVZ and add it to the industry equity premium,
I'd have an estimate of PVZ's cost of equity.
And of course I erased the, what did I find that bond yield was?
For heaven's sake, I can't even remember.
I erased it.
Oh well.
The yield to maturity was, I think it was something like 4.79 percent, something like
that.
I can't remember what I put down.
I erased it for some reason.
So in other words, my guess would be that the cost of equity for PVZ would be that yield
to maturity 4.79 percent plus the equity premium of 17.90 percent.
That'd be my stab.
So I'd take the 17.9 percent plus, that's the industry equity premium, and add it to
the yield to maturity for this company's debt overall, 4.79, 22.69 percent.
It's a stab.
The funniest thing is, it's the least accurate.
And it almost always is quite a ways away from the dividend growth model result, the
capital asset pricing model result.
However, it is actually quite popular these days.
Aside from the fact that it's easy to calculate, you just get the industry equity premium.
You can even look that up on Standard Ports Global Net Advantage.
Type in the SIC code of the industry, and you'll get this list of all these different
averages for the industry.
Equity premium is one of them you get.
So you can just take a company's bond yield to maturity and add it to the equity premium,
and there you've got the company's, an estimate of the company's cost of equity.
It is usually, and I did it here, if you saw I was trying to think of numbers to do, it's
usually quite a bit higher for some reason than the other two would be.
But still, it's kind of a hot item.
The argument against it is that there are too many factors in any given company that
make it so that looking at averages and applying them to the company is not a good idea.
There's too many weird things about you to consider averages.
Well, the average guy is 5'8".
Now you're not 5'8", are you?
The average guy is 200 pounds.
You're not 200 pounds.
If you are, you need to lay off the food, okay?
Really, all you can eat cheeseburgers at Earl's House of Cheeseburgers?
You got to quit.
Your metabolism is slowing down, like mine did.
But that's the argument against it.
You're looking at too many things about an individual company that are different from
the industry to say, well, the equity premium of the industry is the equity premium of this
company.
No, not likely.
But like I said, it's very popular.
Now, taking all this off, and again, if you know my style, I'll go back and do this again.
But getting to the end, first things first, the term capital structure.
The capital structure of a company is the combination of debt and equity that makes
the total assets.
The capital structure of a company is the combination of the percent of debt and the
percent of equity that makes up the total assets.
The capital structure is a combination of the percent of debt and the percent of equity
that makes up the capital structure.
So in other words, I could say, well, the capital structure is 25% debt, 75% equity.
Where the capital structure is 50% debt, 50% equity.
That's all it says is how much debt and how much equity as percentages add up to 100%
of the company.
That's all it is.
Nothing complicated about it.
However, behind it, most companies have a smaller percent of debt than they do of equity.
25% debt, 75% equity.
10% debt, 90% equity.
Only rarely will you see a company that has a larger percentage of debt than of equity.
I mean, theoretically, you could have a company that's 100% debt, 0% equity.
That would be a pure debt company.
On the other hand, you do see companies that are very tiny on the debt.
5% debt, 95% equity.
They're just some companies that don't use debt in their capital structure very much.
It's a bad idea because you're not achieving gains to leverage, but that's the policy of
the company.
So it can go both ways.
You can have companies that are heavy debt, light equity, or light debt, heavy equity.
Or you could have 50-50.
But the upshot is that we are going after the weighted average cost of capital.
This is one of those golden numbers in companies.
The WAC, weighted average cost of capital.
And unfortunately, it's inappropriately used.
Companies will use WAC to discount cash flows, which it should not do.
Companies will use WAC for other things, which it should use it for.
But essentially, it's just the overall cost of the capital.
Here's how you do it.
The WAC, okay, I guess I'm just kind of doodling here on the board.
So this is the WAC-a-doodle.
Geez, I'm trying hard.
The WAC is the weight of debt times the after-tax cost of debt plus the weight of equity times
the cost of equity.
Now remember that equity could be preferred and or common.
So technically, I could write a little bit more detail by saying WAC is the weight of
debt times the after-tax cost of debt plus the weight of preferred times the cost of
preferred plus the weight of common, WS, times the cost of common.
Just to granularize it if the company has preferred stock.
But one way or the other, that's the WAC.
And there is a really sweet routine for calculating this very rapidly in Excel.
I mean, if you do it by hand, it'll take you quite a while.
Even if you do it in Excel, by what you would think is a normal way to do it in Excel, it
still takes a while.
But Excel has a nice little trick for calculating weights really fast and then multiplying the
weights times the costs just in the blink of an eye.
It's just amazing.
I've used this before, but unfortunately, my version of Excel that I have at my flat
just doesn't want to do it.
It just keeps bitching at me about it.
I don't know why.
But here on this computer and on your laptops, if you've got Office 365 loaded, it does it
in the blink of an eye.
It's just a really, really gorgeous thing.
Let me show you.
I'm just going to show you a quick dirty example of it.
Let's say you've got, oh, first things first.
I'm going to show you a nice little trick.
Right click on your sheet, view code.
When you see general, click on worksheet.
Now I'm going to write a little tiny snippet of VBA just in case you get a sense of it.
If you're taking that, if you start taking that Wall Street Prep Excel crash course,
you'll see this.
I'm going to write cells.entire column, try that again, column.autofit.
Did I do that right?
My eyes are shot right now.
Now close out that.
Let's do some things.
First of all, the component.
Did you see what it did?
It'll automatically, watch, watch again.
The dollar value, watch.
Do you see what it's doing?
It's automatically adjusting column widths.
It doesn't do that unless you type that little snippet of VBA code.
I don't know why they don't make that just part of Excel, but they don't.
Now wait.
So let's say debt.
I'm just going to throw some numbers in here.
Preferred, common.
Let's take the debt.
Let's say that there's $12 million in debt.
Let's say the preferred is $2 million.
Really?
Now let's say that the equity is $28 million.
Now the old way to do it would be to add these up and then take each one, like $12 million,
divided by the sum.
$2 million divided by the sum.
$28 million divided by the sum to get the weight.
But there's a faster way.
Watch how I do this.
I'm going to highlight that column.
Now you see that little icon that just popped up there?
That's in analytics.
Click on it.
Now find the totals and skid over percent of totals.
Well spank me Jesus.
Look at that.
You got your weights.
Now yes.
Got it?
That's a very cool thing.
Now watch this one.
We're going to get the whack.
You ready for the whack?
Whack equals some product of this column by that column.
I forgot to put in the cost.
God.
The cost of capital, sorry about that cost.
Let's say that the cost of debt is 5.8%.
I was getting ahead of myself.
The cost of preferred is 7.25%.
And the cost of common stock is 14.66%.
Now I can get the whack.
Merge and center and then left flush.
Now equals some product.
I knew I was doing too good there.
Some product of the weights, by the costs.
So this company's weighted average cost of capital is 11.78%.
I used to spend about a half an hour just doing this part.
And now it's just a couple of stupid pet tricks and you're there.
I'll do this again tomorrow.
You notice that little trick right there with this.
When you highlight an array, that icon pops up.
Look at all the different things.
You can do charts.
You can do totals, tables.
There's where you do your spark lines.
It's all that is in that little box right there.
But for us, there you go.
That's how you can get the weighted average cost of capital.
We'll just do it again next time on Wednesday and I'll build a model so that you can take
home a template.
That's all I have for you today.
I thank you.
I'll see you tomorrow.