Finance Project

Project 3: WACC Calculation

The Weighted Average Cost of Capital (WACC) is the average cost of debt and equity that General Mills applies in financing its capital structure. An optimal capital structure is achieved by having an appropriate percentage of debt and equity that the company can use in the project financing (Heinrichs et al., 2013). The WACC calculation is given by the formula;

WACC = W d R d (1-T) + W s R s; where

WACC – weighted average cost of capital

W d - weight of debt in the capital structure (given as a percentage of the total capital)

R d – Cost of Debt

T – Corporate tax rate

W s – Weight of common stock given as a percentage of the total capital in the capital structure

R s – Cost of common stock

To establish the Weighted Average Cost of Capital for the General Mills, there are a series of steps that must be taken to determine each element in the WACC formula. Several assumptions will also be made in the analysis.

Step 1: Calculation of the cost of equity (R s)

To calculate the cost of common equity for the company, the Capital Asset Pricing Model (CAPM) will be used. The CAPM approach is given by the following formula

E (R) = R f + beta (R f - R m) where;

E(R) – expected return from the common equity (represents the cost of equity)

R f – Risk – free rate, R m – market risk premium

Beta =0.625825 (as reported in Yahoo Finance)

Risk- free rate = 10%

Market-risk premium = 8%

Based on the available bond information about General Mills, we assume that the risk-free rate is 10% while the market risk-premium is 8%. Therefore, using the CAPM approach, the cost of equity is determined as follows;

E(r) = 10% + 0.625825 (10% - 8%) = (10% + 1.25165) = 11.25165

Cost of equity (R s) = 11.25%

Step 2: Cost of Debt

The cost of debt (R d) for General Mills is obtained from the bond ratings for the corporate bonds as listed in Yahoo Exchange. The figure below represents the bond ratings with different maturities for corporate bonds as reported by the ValuBond (Yahoo Finance).  According to the data provided in the figure 2, the 20-year bond rate is 4.02% for the 20 – Year AA bond. Therefore, in this analysis, we assume based on the available data that the cost of debt for General Mills is 4.02%

Figure 2: The corporate bond yield for General Mills as reported by Yahoo Finance

[pic 1]

Step 3: Calculation of weight of debt and equity

        The weight of debt and equity for General Mills is determined as a percentage of the total capital that the company has in its capital structure. For the determination of weight of equity (W s) and weight of debt (W d), the financial data for the fiscal year 2015 will be used as reported in the 2015 annual report.

Weight of Debt (W d) = [pic 2]

Book value of debt (all debts amount in balance sheet) = short-term + long-term debt