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Is your WACC out of Whack?

Is your WACC out of Whack?. The key to building stockholder value. Maximum Enterprise value includes cautious use of fixed income securities. Why Two pronged answerer Tax Advantage Lower returns to the first in line. Example .

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Is your WACC out of Whack?

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  1. Is your WACC out of Whack? The key to building stockholder value

  2. Maximum Enterprise value includes cautious use of fixed income securities • Why • Two pronged answerer • Tax Advantage • Lower returns to the first in line

  3. Example • Assume Entity has $1,000,000 in earnings before interest and taxes and 100,000 shares outstanding. • Return on assets =20% • Combined Tax Rate 40% • Tax on Income $400,000 • Available to Common shareholders $600,000 • If appropriate discount rate = 15% • Market Value =$4,000,000 = $40/ share

  4. Example continued • Assets required $5,000,000 • Spontaneous liabilities, i.e. payables and accruals =$1,000,000 • Equity Required $4,000,000 • Book value equity = market value equity

  5. Introduce the first element of interest bearing debt • $1,000,000 debt at 8% • New EBIT = Old EBIT = $1,000,000 • New Taxable income down by $80,000 • New after tax Net income down by $48,000 • Things are shrinking • Why do it?

  6. The number of shares is shrinking also • The old balance sheet had $5,000,000 in assets less $1,000,000 operating liabilities, in payable and accruals a net of $4,000,000 in equity. Market and book were equal • The new balanced sheet still has $5 million in assets, $1million in operational liabilities, $1 million in interest bearing debt, but book equity equals $3 million and has a market value of $3.68 million

  7. Nice going, can we do it again?

  8. The Problem • Both the debt and equity investors begin to demand higher returns on their investment to compensate for the added risk of a leverage investment • At some point the enterprise value begins to drop.

  9. Finding the Lowest Weighted Average Cost of CapitalWACC • Continuing and ongoing problem • Recent emphasis on pricing of risk has change the market • An ideal WACC two years ago is out of date • The optimal debt level as fallen across the board and in some industries the drop has been dramatic

  10. Theoretical WACC Optimum

  11. Definite retrenching of Debt to equity ratios is in order • Some debt is still beneficial • Not the same ratios

  12. Debt Ratios should Shrink • The reduction in debt ratios does not automatically dictate smaller balance sheets • See Financial Bully in the Playground • Aggressive strategy on accounts receivable and inventories may improve organic growth opportunities • Acquisition of competitors are reasonable multiples is possible in this market

  13. Source of Capital for • Reduction of debt ratios • Aggressive working capital strategy • Acquisition opportunities • Plowback of retained earnings • Or • Look to Private Equity Groups

  14. Plowback of Retained Earnings • Plowback of retained earnings may be too slow for your bank or your bank’s regulators • If Tom Edison had grown his company exclusively by retained earnings the U.S. would be electrified as far as Pittsburg Pennsylvania.

  15. What is additional equity appropriate for? • Growth capital, either organic growth or acquisitions • Intergenerational transfer • Management buy-out or buy-in • Reduction of minority shareholders • Personal liquidity and diversification • Elimination of personal guarantees and obligations • Or simply retirement.

  16. Jack Cassidy • Kepler Financial • http://www.Keplerfinancial.com • SELLER SERVICES • Exclusive Representation • Exit Strategy & Planning • Business Valuations • Growth Capital Services • Consulting • BUYER SERVICES • Exclusive Representation • Business Valuations

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