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Sir in WACC related questions if we are given two debts, Bond and Bank Loan we calculate their individual Kd and add them together to get total Kd right? But where do we put the book value of the Bank Loan in our WACC calculations???
e.g Burse Co. question June 2008. Where do we put the Bank Loan book value in our WACC formula, do we add it to the Market Value of Debt? Please explain I am confused how examiner has shown the working.
Thanks
I am not sure what you mean by ‘adding their individual Kd’.
The cost of a bank loan is the rate of interest they are charging times (1-t) because of the tax relief.
When you come to calculate the WACC, you take the weighted average of all the sources of finance (in this question there is equity, debt, and bank loan).
The market value of a bank loan is always simply the total amount of the loan which will be the figure on the balance sheet.I meant to ask where do you put the Bank Loan value in the WACC formula, does it add into the market value of debt?
No – when there are three sources of finance (as there are here – equity, debt, and bank loan) then you cannot use the formula as it is printed on the formula sheet. You have to take the weighted average of all three costs.
So, for instance, suppose there is equity with market value of 1000 and cost of 15%; debt with market value of 400 and cost (after tax) of 8%, and bank loan of 100 with cost (after tax) of 5%.
So the total market value of all is 1000 + 400 + 100 = 1500.The WACC is (1000/1500 x 15%) + (400/1500 x 8%) + (100/1500 x 5%) = 12.47%
Hope that helps 🙂
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