1. A Step-by-Step Guide to Estimating the WACC in Practice

In reality, it often occurs that we don't have enough information for the firm we are interested in to compute its various costs of capital, or that the information in question is not very useful. Most prominently, this is generally the case when we try to value unlisted firms. To get around this problem, we often have to look at other firms. What follows illustrates the various situations we might encounter and how exactly we can estimate the WACC in these situations.

Remember from the previous chapter that we can compute the WACC as follows:

 

WACC = \( k_D^* \times(1- \tau_C ) \times \big(\frac{D}{D+E}\big)^*+k_E^* \times \big(\frac{E}{D+E}\big)^* \).

 

Alternatively:

WACC= \( k_A-k_D^* \times \tau_C \times \big(\frac{D}{D+E}\big)^* \).

 

Now suppose we want to estimate the WACC of the hypothetical company Coffee. How do we proceed? We can distinguish five typical situations, which are discussed in detail in the following sections:

  1. The firm has traded shares and operates at its target capital structure
  2. The firm has traded shares and plans to change its capital structure
  3. The firm does not have traded shares
  4. The firm pursues a project in one of its divisions
  5. The firm pursues a cross-divisional project