Amazon, an online retail, and information technology services giant.
According to finbox.com, Amazon’s Weighted Cost of Capital (WACC (Weighted
Average Cost of Capital)) is currently 9.75%. WACC is the rate that the company is
expected to pay, on average, to its security and finance assets.
Their cost of equity range is 9.5%-11.5%. A range of factors, both internal and external,
can impact a company's WACC. Currently the change in interest rates would be a major
factor that would impact Amazon. Over the past few months, the Federal Reserve has
steadily increased interest rates. As the interest rate increases, the cost of capital increases
and the risk of default. The longer the time to maturity on the debit, the longer it will take
for the impact to be felt. Another factor for risk is that interest is deductible and affects the
company's tax burden and net profit. The higher the tax rate, the higher the interest and the
higher deduction. The lower net profit due to the deduction impacts on the shareholders'
equity. (no date) The Complete Toolbox for Investors.
The company I selected for this exercise is Chevron Corporation in the Energy Sector. As
of today 12/7/8, Chevron’s weighted average cost of capital (WACC) is 10.55% according
to Focus Guru (see citation below).
Chevron (No. 16 on the Fortune 500) reported second quarter earnings of $11.6 billion. On
June 8, Chevron’s stock price reached an all-time high of $182.40 as national average for
gas prices hit an all-time high at $5 per gallon. The company’s WACC has fluctuated over
the past couple of quarters as a direct result of its stock prices (Estrada, 2022).
There are many factors that can impact Chevron’s WACC, including, the federal reserve
interest rates and the current economic conditions. As the Federal Reserve adjusts interest
rates, it impacts the risk-free rate or the theoretical rate of return for an investment that has
zero risk of financial loss. An increase or decrease in the federal funds affects a company’s
WACC. The hike in the Federal Reserve interest rates have caused an increase in
Chevron’s WACC cover the past year or so (Estrada, 2022)
Another factor that has caused an increase in Chevron’s WACC is the challenging
economic conditions over the past 2 years. The response of WACC to economic conditions
is that bad economic conditions increase risk of default, which increases the WACC
(Folger, 2022).
WACC can simply be used as a discount rate which presumes risk of a particular or
specific is equal to the overall risk of the firm’s business environment. A percentage
premium should be added to WACC recognize an apt discounting rate if the project has
higher risk than the norm.
WACC assumes the capital structure in place is ideal, which may not be achievable in
real world.
WACC is based on market values of capital that keep on changing thus WACC will
transform over time. However, it is assumed to remain constant during the economic life
of the project. In fact, market value can change rom minute to minute in the real world.
d It is based on historical data and statistics, especially whenever determining the cost of
each component as like in determining the cost of equity (Ke) the past year's DPS is used
whereas from the past stream of dividends the growth rate is estimated. So, it looks like we
are “mixing apples and oranges”.
http://www.expertsmind.com/questions/weaknesses-of-wacc-as-discounting-rate-
30130855.aspx
Estrada, S. (2022, October 7). As Chevron's stock hovers near its all-time high, the CFO is
trying to 'win back investors to energy'. Fortune. Retrieved December 7, 2022, from
https://fortune.com/2022/10/07/chevron-stock-all-time-high-cfo-investors-energy/
Folger, J. (2022, September 1). Interest rates and other factors that affect WACC.
Investopedia. Retrieved December 7, 2022, from
https://www.investopedia.com/ask/answers/070114/how-do-interest-rates-affect-weighted-
average-cost-capital-wacc-
calculation.asp#:~:text=When%20the%20Fed%20hikes%20interest,economic%20conditio
ns%2C%20and%20market%20conditions.
https://finbox.com/NASDAQGS:amzn/models/wacc (Accessed: December 8, 2022).
Folger, J. (2022, September 1). Interest rates and other factors that affect WACC.
Investopedia. Retrieved December 8, 2022, from
https://www.investopedia.com/ask/answers/070114/how-do-interest-rates-affect-weighted-
average-cost-capital-wacc-calculation.asp
