Question

Estimate your firm's approximate WACC; use the most recent year's debt ratio to find the weights of debt and equity. If your company issues preferred stock, for simplicity's sake, ignore it. The cost of debt will be the approximate YTM calculated in Week 5. Use CAPM to calculate your company's required rate of return on the stock. The beta was determined in Week 6; use the current 10-year Treasury bonds' YTM as the risk-free rate. Using a reliable source, research the current market's expected rate of return (for example, the S&P 500). Be sure to mention all reference sources. My company is CVS Health Corp. Thank you

Answer 1

WACC = weight of debt*cost of debt*(1-tax rate) + weight of equity*cost of equity

Let us first start with the weights. The company's debt to capital ratio = 0.42 and so its equity to capital ratio = 1-0.42 = 0.58. This is as per the figures for December 31, 2017 and is given in the 2017 annual report of CVS. (This can also be obtained from https://www.stock-analysis-on.net/NYSE/Company/CVS-Health-Corp/Ratios/Long-term-Debt-and-Solvency)

Next we find the cost of debt. Cost of debt for CVS = 3.8949%

Cost of equity = risk free rate+ beta*(expected return of the market - risk free rate)

Risk free rate = 2.93% (i.e. this is the 10 year Treasury Bond's YTM) and market premium = 6% (from Yahoo finance) and beta = 0.85 (again from Yahoo finance)

Thus cost of equity = 2.93% + 0.85*6% = 8.03%

Now, WACC = weight of debt*cost of debt*(1-tax rate) + weight of equity*cost of equity

tax rate (from the company's 2017 annual report) = 29.1%

Thus WACC = 0.42*3.8949%*(1-29.1%)+0.58*8.03%

= 5.82%