WACC is calculated by multiplying the cost of each capital source (debt and
equity) by its relevant weight by market value, then adding the products
together to determine the total (Hargrave et al., 2022). According to Value
Investing, as of December 2022, the selected company used is Target Corp.
This corporation is in the Retail industry. The WACC of Target Corp (TGT) is
8.4%. The Cost of Equity of Target Corp (TGT) is 9.15%. The Cost of Debt of
Target Corp (TGT) is 5.05%.
There are a few factors that affect Target Corp WACC. The Federal Reserve
(Fed) affects short-term interest rates and WACC through the fed funds rate
(Folger & Brock, 2022). The fed funds rate is referred to as the interest rate at
which one bank lends money, through the Federal Reserve, to another bank
(Folger & Brock, 2022). As the Fed makes adjustments to interest rates, it
causes changes in the risk-free rate, the theoretical rate of return for an
investment that has no risk of financial loss (Folger & Brock, 2022). An
increase or decrease in the federal funds rate affects a company's WACC
because the risk-free rate is an essential factor in calculating the cost of capital
(Folger & Brock, 2022). Other external factors that can affect WACC include
corporate tax rates, economic conditions, and market conditions. Interest paid
on debt is tax deductible. Higher corporate taxes lower WACC, while lower
taxes increase WACC (Folger & Brock, 2022). The direct effect of good
economic conditions is to decrease the risk of default, which decreases the
default premium and the WACC. Fed will eventually raise interest rates and
increase WACC (Folger & Brock, 2022). Market conditions can also affect
WACC. Increasing volatility in the stock market will raise the risk premium
demanded by investors (Folger & Brock, 2022). That increases the cost of
raising additional capital for the firm. Higher volatility is also likely to decrease
the value of existing equity, which makes it less expensive for the firm to buy
back shares (Folger & Brock, 2022).
References
Automated DCF and WACC: Intrinsic value. ValueInvesting.io. (2022,
December). Retrieved December 8, 2022, from
https://valueinvesting.io/TGT/valuation/wacc
Folger, J., & Brock, T. (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
Hargrave, M., Kindness, D., & Kvilhaug, S. (2022, November 3). Weighted
average cost of capital (WACC) explained with formula and example.
Investopedia. Retrieved December 8, 2022, from
