Kohler Corporation :

WACC

Where

kd = Cost of debts

Tc = Tax rate (adjustment of interest expense)

D = Value of debts

E = Value of equity

V = Total value of firm

Steps of calculating the WACC

Cost of debts

Irredeemable

If debts are irredeemable, so Kd is calculated as under

It was assumed that debts were irredeemable in this case, so it was calculated as the formula mentioned above.

Redeemable

The kd or cost of debts is calculated by IRR method if debts are redeemable. Two appropriate discount rates were selected for discounting in which one rate would give positive NPV whereas the second discount rate would give negative NPV. The formula of IRR is

Where

a = lower discount rate

b = higher discount

NPV(a) = positive net present value

NPV(b) = negative net present value

Debts

Market value of debts or D is used in calculating the WACC. But in this case, the market value and book value of debts were same. Value of debts taken from balance sheet see exhibit 3a.

Equity

Market value of equity or E and book value were same in the case. See exhibit 3a for equity value.

Value of total entity

Total value of entity or V was calculated by summation of total value of equity and debts.

Taxation

Tax rate was calculated by using this formula

Cost of Equity

The ke or cost of equity is calculated by using dividend growth model and capital asset pricing model. But in this scenario, beta was not given of Kohler’s company so its competitors’ beta was used to calculate the cost of equity. Asset beta of competitors was geared by the debt equity ratio of Kohler.

Steps to follow

Assets beta

First find the asset beta through unlevered the equity beta of competitors by using the debt to equity ratio. The of formula assets beta is as under

Equity beta

Levered the assets beta into equity beta by using debt to equity ratio of Kohler’s company.

Capital asset pricing model

Calculate the cost of equity by using capital assets pricing model.

Ke = cost of equity

Rf = risk free rate of return

Beta= measure the systematic risk associated with company’s securities

Rm = market return

Risk free rate of return

Normally investments in treasury bills of government are considered risk free investment. Risk free rate of return was given is 6% in Exhibit 8.

Market return

Market return rate is normally given in the case, if it is not given so it is calculated by taking mean or geometric mean of historical market returns.

Discounted cash flows

It is the discounting method that is used to see the attractiveness of the investment choice and alternative. It uses the free cash flows of company and discount rate (normally WACC) to calculate the present value of cash flows..........................

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