Examine Ford Motor Company, in the Automobile Manufacturer industry.
Ford is an automobile manufacturer with a WACC of 6.56% (Ford Motor Co
2022). They also have a cost of equity of 11.6%, and effective tax rate of
13.1% and a cost of debt of 6.55%.
There are many risks/factors that the Ford Motor Company and the
Automobile Industry are facing that could impact the weighted average cost of
capital (WACC). Some of them the company can control and some of them
that are out of the control of the company. Some of these factors include:
1. Federal Reserve Interest rate- this is the rate at which banks lend funds
maintained at the Federal Reserve. As this rate increases the WACC also
increases (Ehrhardt & Brigham 2019). It causes changes in the risk-free
rate, which is an essential factor in calculating the cost of capital. a The
Federal Reserve has increased the federal funds rate by 3.75% in less
than one year and has recently been raising the rate by .75 percentage
points each time they announce a raise (Smith 2022). This increase will
undoubtedly also raise the WACC for Ford Motor Company.
Furthermore, the Federal Reserve continues to be hawkish on raising the
rate, indicating that a terminal rate of over 5% is likely. A lot of these
rate hikes are fueled by inflation, which was over 7.7% in October. Until
inflation is under control the rate is expected to increase. This increase
in Federal Interest Rate can be expected to continue to increase the
WACC for Ford Motor Company.
2. Corporate Tax Rate- This rate is influenced by the president and set by
congress; this is used to calculate the after-tax cost of debt used in
WACC (Ehrhardt & Brigham 2019). As corporate taxes go up WACC
goes down since a higher rate produces a larger tax shield. Recently the
tax, climate and energy bill passed by the Senate Democrats includes a
15% minimum tax on domestic profits of large American companies
(Davison 2022). This bill would require Ford Motor Company to both
used longstanding tax accounting methods, and by applying 15% rate to
the earnings they report to shareholders (Davison 2022). With a current
tax rate of 13.1% (Ford Motor Co 2022) This would mean a tax increase
for the company. This tax increase could be expected to decrease their
WACC.
3. Economic conditions- while economic conditions impact on WACC is
harder to pinpoint, in general good economic conditions lower the risk
of default, which in turn reduces the WACC (Ehrhardt & Brigham
2019). Currently supply chain disruptions have led to a less favorable
economic situation, as supply chain issues continue Ford Motor
Company should expect the WACC to rise.
All the above-mentioned factors are things that Ford Motor Company is
unable to control, next we will look at some factors that are within the
control of the company. These factors include:
1. Capital structure policy- the cost of debt is lower than the cost of equity,
therefore using more debt and less equity will lower WACC (Ehrhardt &
Brigham 2019). Recently Ford has been using less debt and more of its
equity to finance its projects, reflected in its decreasing debt to equity
ratio. Its debt/equity ratio has decreased from 4.68 to 2.85 over the past
two years (Dybek 2020). This change in its capital structure will in turn
increase its WACC over the coming quarters.
2. Investment policy- If a company invests in an entirely new line of
business, then the marginal cost of capital should reflect the risk of the
new business. The automotive industry’s shift to electric vehicle
recently means that ford is investing a great deal in new business, the
electric automobile business. This change in risk will certainly impact
the WACC of the business, while the electric car market Ford is
investing in, is expected to grow exponentially in the coming years, this
new market will inherently have more risks. From different market
structure, possible higher costs, new manufacturing processes, and
changing capital structure, this new market with new risks will most
likely increase the WACC of the company (Will the electric vehicle
boom go bust? 2022).
References
Davison, L. (2022, August 1). What is the 15% minimum corporate tax senate
Democrats are proposing? Bloomberg.com. Retrieved December 7,
2022, from https://www.bloomberg.com/news/articles/2022-08-01/how-
the-15-us-minimum-corporate-tax-would-work-
quicktake?leadSource=uverify+wall
Dybek, M. (2022, February 5). Ford Motor Co. (NYSE:F): Analysis of
solvency ratios. Stock Analysis on Net. Retrieved December 7, 2022,
from https://www.stock-analysis-on.net/NYSE/Company/Ford-Motor-
Co/Ratios/Long-term-Debt-and-Solvency
The Economist Newspaper. (2022, June 8). Will the electric vehicle boom go
bust? The Economist. Retrieved December 7, 2022, from
https://www.economist.com/podcasts/2022/08/31/will-the-electric-
vehicle-boom-go-bust
Ehrhardt, M. C., & Brigham, E. F. (2019). Corporate Finance: A Focused
Approach (7th ed.). Cengage Learning US.
https://mbsdirect.vitalsource.com/books/9781337910231
Folger, J. (2022, September 1). Interest rates and other factors that affect
WACC. Investopedia. Retrieved December 6, 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,econ
omic%20conditions%2C%20and%20market%20conditions.
Ford Motor Co (NYSE:F). AlphaSpread.com. (2022, December 1). Retrieved
December 7, 2022, from
https://www.alphaspread.com/security/nyse/f/discount-rate
Smith, C. (2022, November 13). Fed faces tough task deciding when to stop
raising rates, official warns. Financial Times. Retrieved December 7,
2022, from https://www.ft.com/content/6ce000d9-dfe3-4746-a6c7-
72fa8181099b
