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I just read "Stern Stewart's EVA" by Al Ehrbar. It looks like a management tool to incent employees to be aligned with shareholders for creating wealth for the company they work for.
TO calculate EVA : Net operating profit after taxes  ((Net Working Capital + Fixed Assets) * The cost of capital).
I was wondering how you find out what the cost of capital is for a corporation. I know we can find out how much their cost of debt is by looking at the bonds a company has outstanding and their rate of return, however how does one find out or calculate the cost of equity capital to then determine the cost of capital for a firm. Even if one can figure this out and find out a corporations EVA and then compare it to years previous is it a valuable index for determing the valuation of a company? Then using it as a criteria to choose a stock.
Thanks to anyone who can help me out with this one!
JV
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I was wondering how you find out what the cost of capital is for a corporation.
The Boring Port board would be the best place to discuss this. But, the short answer for me is to use about 11% as that's the historical rate of return of the market.
There's actually a formula for it, but I don't recall it off the top of my head.
Phil
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jmviap wrote: I was wondering how you find out what the cost of capital is for a corporation. I know we can find out how much their cost of debt is by looking at the bonds a company has outstanding and their rate of return, however how does one find out or calculate the cost of equity capital to then determine the cost of capital for a firm.
JV
The weighted average cost of capital (WACC) for a company is calculated as follows:
(Cost of Debt)*(1T)*(D/A) + (Cost of equity)*(E/A)
where:
Cost of Debt = Weighted average of all outstanding debt
T = Tax Rate
D/A = ratio of debt to assets
Cost of Equity = Return on Equity (5 year appreciation + dividends is a good approximation)
E/A = ratio of equity to assets
That being said, its interesting to note that many companies use a benchmark, or desired rate for EVA calculation instead of the actual rate. For instance, CocaCola uses 12% as its worldwide WACC. Why? Its 1% per month. Simpler is better.
Steve (Simple Simon)
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Sorry.
Cost of Debt = Weighted average of all outstanding debt
Should read:
Cost of Debt = Weighted average interest rate of all outstanding debt...
Steve
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The fastest way to calculate a company's cost of capital for EVA is to use a financial metric called "beta" that can be found on many web sites (including TMF!).
The formula is:
Cost of capital = riskfree rate + beta * (equity risk premium)
I typically use 1year Tbills for the riskfree rate. Longterm average is about 6%.
Equity risk premium, according to leading financial textbooks, is about 8.4% longrun average.
Win
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It seems that we can obtain industry averages for publically traded companies, but cannot actually find out what the Cost of capital for a single company.
I guess the way I lookat it is that a company takes certain risks when using money to further their interests, not all companies within an industry take the same level of risks to achieve their goals, the market will charge them one cost if they are using debt, certainly lower than the cost associated with a stock offering. When a company floats new shares of stock the "market" will demand a certain rate of return, is it possible to figure that number out or does one just have to use industry averages?
JV