0:06

The weighted average cost in capital, we know what it is.

It is the average cost of capital, but it's weighted by how much debt I have and

how much equity I have relative to the total value of my company.

0:20

How do you calculate it?

Where do you get those numbers so

you can actually get a hurdle rate that makes sense for your organization?

Your income statement, your balance sheets.

Here's the formula for WACC.

It's rd(1- t) times the ratio of my debt to

my value plus RE, which is the cost of my equity,

times the weight equity to the ratio of my value.

0:49

That's where I'm getting my weights.

So, what I'm going to do, is I'm going to show you where you find each of these

numbers on the income statement and the balance sheet.

And then we're going to do the calculation.

We're going to calculate WACC for UPS.

All right, here's what we're going to do, we're going to go back and

forth between this sheet and my Yahoo Finance for UPS.

Let's start by trying to calculate t.

All right, here I have my income statement for UPS, pulling this thing up.

My income tax expense as a ratio of my income tax before

earnings tells me what my relative tax rate is.

So here if I look, we're going to do this for 2013.

Here I've got my income before taxes and my interest and my income tax expenses.

So, my income tax expenses are 2,302.

And then divide that by my income before tax,

6,674, gives me a tax rate of 34.5%, 34.49%.

So, let's go put this right in here.

0.345, all right, where did I get that?

That's the ratio of my income tax expense to my earnings before tax.

Both of those from my income statement.

2:33

Here on my income statement I have interest expenses,

interest expenses of $380 million.

This is the expenses that I'm paying for money,

paying this to banks, other financial intermediaries.

So that becomes my numerator.

2:51

My denominator, I'm going to go over to my balance sheet and

I'm going to look at the total liabilities that I'm carrying,

and I'm going to look at my short-term debt and my long -erm debt here.

So I've got short-term debt of $48 million and long-term debt of $10 billion 824.

So I'm going to add my 10 billion 824

to my 48 and I get 10,872.

So I take the ratio of 380 to 10,872,

and I get about 3.5%.

So right here, I'm going to go 0.035.

Now, again, I've approximated this.

I could go to Morningstar, S&P, and

look at what the bond rating is, and then adjust for how much

UPS is specifically carrying in each type of bond and do a weighted average.

I will show you that in a separate video.

For now, we're just going to use this proxy.

3:57

Now, I've got my weights, D to V and E to V.

Now, the first thing you should know is that the total value of the company was

your debt plus your equity.

So, in order to calculate my total value, I need both my debt and my equity.

My equity, I'm going to get by looking at my company.

And I'm going to go up here to summary.

Excuse me.

And right here, there's a line on my summary called market capitalization.

Market capitalization is the price of the shares of stock, in this case $97.48,

times the total amount of shares that are outstanding.

So you take the price times the all the shares that are out there,

you get your market capitalization.

That is the equity value of this company.

And so, the equity value is 89.05 billion.

So let's just write down E here is 89.050, in billions.

The debt of my company, let's go back here and I'm going to look at my balance sheet.

My debt on my company is any kind of liability that I'm carrying,

not just the words debt, but anything.

So if I look at my total liability, my total current liabilities and

my total long-term liabilities, I get 29 billion 738.

So, my debt here is 29,738.

When I add my 89,050

to my 29,738,

I get 118,788.

This is the total value of my company.

5:54

Lastly, I've got the return on my equity.

The return on my equity we've already calculated using the CAPM, or

the capital asset pricing model.

And for our example, we've calculated

a CAPM of about 10.6, so 0.106.

If you don't remember, you can go back to the other video and

see how we calculated this.

Now, all I need to do is plug and chug.

Put the values into my formula and actually just calculate them, okay?

So, what we're going to do right here is,

we're going to calculate my WACC right here on the fly.

So, let's do it.

Here's my WACC,

it's equal to 0.035

times 1 minus 0.0,

my tax rate, which is 345,

times the ratio of my debt

29,738 over 118,788.

Plus 0.106 times the ratio

of my equity 89,050 to

my total value, 118,788,

and out will pop a WACC.

I want you to pause this.

You try to calculate this and we'll see if we get the same number.