DCF WACC
- 03:06
Calculating the WACC to be used in the DCF
Transcript
REIT Discounted Cash Flow valuation model, part 1, Weighted Average Cost of Capital. We are going to go step by step through a REIT DCF, and the first thing that we're going to do is calculate the weighted average cost of capital or WACC. Before I do that I'm just going to show you how the model is set up. We have at the top some information about the share price and shares outstanding. Now, we've already calculated shares outstanding in the NAV model, net asset value model so if you want to have a refresher on that, take a look back at the NAV tab. We have below that our weighted average cost of capital. And off to the right we have a current enterprise value calculation that is driven by obviously the market cap as of the share price at the valuation date. This is just something for us to refer back to. The cost of capital calculation is at the top of the model followed by a shares outstanding calculation which will incorporate the equity issuances and we have our terminal value methods both multiple and perpetuity. Below this we have our actual free cash flow calculations. And then lastly, our sensitivities. First thing we're going to do is calculate the cost of capital. We have our risk-free rate, and I have a note here about that. This is the current 10-year treasury rate. We have our equity risk premium. Now, this is an assumption obviously, equity risk premium is something that a lot of investment houses will publish internally. You can certainly do some research online to see where current market trends are, but this is a statistic that that doesn't change every day. It usually takes some market movement, major market movement to change the equity risk premium. Then we have our median levered beta from the Comps and this is the an unlevered Beta, which has been re-levered at the target capital structure. And again, typically for REITs, we see Betas below one. I'm going to calculate the cost of equity. It's going to be the risk-free rate plus the equity risk premium times the Beta and I get 7%. I'm now going to move down to the debt portion of the WACC. And first thing I have here is an assumption for my planned debt-to-total-cap-ratio which is debt over debt plus equity, and that's at 65%. My cost of debt is 5% and I have a note here for this. It's just a reminder that we are not taking the after tax cost of debt because there's very little to no tax shield in a REIT. In terms of where we get the cost of debt, that's something that we can either look at the comps or we can look at the debt schedule of the target REIT. Therefore, the overall discount rate is going to be the cost of debt times the debt-to-capital-ratio plus the cost of equity times one minus the debt-to-capital-ratio, which is the equity ratio and we get a discount rate of 5.7%.