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How to Calculate Market Value of Equity?

The market value of equity is also referred to as market capitalization. To calculate the market value of equity, multiply the total
number of shares outstanding by their current price per share

Estimating market value of debt


The market value of debt is usually more difficult to obtain directly, since very few
firms have all their debt in the form of bonds outstanding trading in the market. Many
firms have non-traded debt, such as bank debt, which is specified in book value terms
but not market value terms. A simple way to convert book value debt into market
value debt is to treat the entire debt on the books as one coupon bond, with a coupon
set equal to the interest expenses on all the debt and the maturity set equal to the facevalue weighted average maturity of the debt, and then to value this coupon bond at the
current cost of debt for the company. Thus, the market value of $1 billion in debt, with
interest expenses of $60 million and a maturity of 6 years, when the current cost of
debt is 7.5% can be estimated as follows:
Estimated Market Value of Debt =
million
If you want a more precise estimate, you can estimate the market value of each debt
issue separately and adding them all up at the end.

Calculating the
Weighted Average Cost of Capital (WACC)
for a Company
For use in Conjunction with the Firm Valuation Project

First ensure that you have read relevant pages in the text. Some important sections
would include the following, but you may also double-check the references in the
text by using the index [see: Cost of Capital and Target (optimal) Capital
Structure, etc.]:

The important Chapter in the text is the one entitled "The Cost of
Capital," with a particular focus on the section entitled The Weighted
Average Cost of Capital and the section Four Mistakes to Avoid at the
end of the chapter.
The WACC formula discussed below does not include Preferred Stock. Should
your company use PS, be sure to adjust the equation for it, and see the section in
the chapter on the Cost of Preferred Stock.
The WACC formula that we use is:
WACC = wdrd(1-T) + wsrs
We need to know how to calculate:
1. rs the cost of common equity. Use the Security Market Line (SML) this
is why you learn how to calculate a companys beta and also why you learn
how to find the appropriate risk-free rate and market-risk premium. For a
review, see the section the text, The CAPM Approach.
2. The weights (wd and ws note that: wd + ws = 1; so you only have to
calculate one of them). We need to calculate the weight of debt and the
weight of equity (for the cost of debt, this simply means: what proportion of
the firms financing is by debt?). There is a lot to say here, simplified as
Theory 1, Theory 2 and Practice:
a. Theory 1: Theory says that we should use the target weights along
with the market values of both debt and equity (see the Four
Mistakes to Avoid). But the market value of debt is typically difficult
to calculate, because we need to know the YTM (which is r d) for all of
the companys debt, but we cannot calculate the YTM without having
the current prices of the companys outstanding bonds, and most
companys bonds do not trade (i.e., they will not have up-to-date or
current prices remember how to calculate the price (value) of a bond
on your calculators?!). As a result, at least for the group project, we
go
to
Theory
2.
b. Theory 2: Theory also says that we should use the TARGET weights,
but this is a management decision, and as outsiders we do not have

access to the thoughts of the CFO or CEO. So we should look instead


to the historical pattern of the use of debt (mix of debt and equity),
and this is one reason that you should have about 10 years of financial
data.
c. Practice: Since we cannot work according to the strict theory of
finance, we have to estimate the relevant weights. As a result, we will
use
the
formula:
wd = Book Value of Debt / [Market Value of Equity + Book Value of
Debt]
The book value of debt is calculated by adding up ALL of the debt on
the balance sheet. This will typically be the sum of Notes Payable,
Current Portion of LT Debt and Long-Term Debt.
The market value of equity is the Market Cap, and equals the
number of (common) shares outstanding multiplied by the
price/share. Note that the timing of this value should coincide with
the book value of debt. For example, if you calculate the book value
of debt as of 12/31/03, then the market cap should also be calculated
for that date. Be very careful about using the reported Market Cap on
Yahoo.finance it may not have the same timing.
By using this formula, you should be able to track the companys use
of debt over many years. Finally here, you may also calculate the
straightforwardDebt Ratio (as defined in the text in the chapter on
the analysis of financial statements), which would use the book value
of common equity instead of the market value. This is not a
recommendation to use that ratio for the WACC, but the Debt Ratio
may be useful for comparison.
3. r d; the cost of debt. There may be more than one acceptable approach to
calculate or estimate a companys cost of debt (be sure to read the
text!). One relatively straightforward method is to discover the companys
debt rating (e.g., by Moodys). This can usually be found on the companys
10K (see the link on my homepage) and doing a word search for rating or
debt rating. For a discussion of bond ratings, see the text (look in the
index). If you can find the debt rating for your company then you can carry

out the following steps (if you cannot find a bond rating for your company,
you might try to estimate/guess what it is by considering your companys
beta and comparing the bond ratings for companies with similar betas). If
you are not able to find a bond rating readily, you can register (for free)
at Standard & Poor's and at Moody's to find company ratings. You may also
find other interesting and useful information there. For a general discussion
of what the ratings mean, see the information from these rating agencies on
my
homepage
at
the Bond
Rating link.
Once you have the actual bond rating or an estimate you can then find or
estimate your companys cost of debt by going to Yahoo.finance and
clicking on theBonds/Rates link (http://bonds.yahoo.com/rates.html). Look
at the yields for the 20 year Corporate Bonds by rating. If your companys
bond rating is listed, youre in luck. If it is not listed then you can estimate
the cost of debt. For example, if the AAA yield is 6.50%, the AA yield is
6.75% and the A yield is 7.00%, you can see a pattern (equation). For every
increase in risk (from AAA to AA), there is a 0.25% increase in the yield. If
your company has a BB rating, then it is two steps below the A rating, so
you should add approximately 0.50% more to the 7.00% for the A rating,
giving you a cost of debt for your company of about 7.50%. Note that this
approach assumes a linear equation for the cost of debt (which may not be
strictly true).
4. The corporate tax rate ( T ). Be sure to read the section in the text on
Corporate Income Taxes (Chapter 2). The correct tax rate for a company is
themarginal tax rate for the future! If you expect your company to be very
profitable for a long time into the future, then the tax rate ( T ) for your
company should probably be the highest marginal tax rate applicable for
corporations. But there are times when companies can obtain long-term tax
breaks so that their tax rates may be lower than the stated (regulated) tax
rate. Consequently you may want to calculate several/many
historical effective tax rates for you company. The effective tax rate is the
actual taxes paid divided by earnings before taxes (on the income
statement). You can calculate/consider these rates for the past 5-10 years
and then compare this effective tax rate to the legally mandated highest
marginal corporate tax rate. If the past historical effective rate is lower than
the marginal tax rate, there may be a good reason for using that lower rate in
your pro formas.