Well, okay, let's fire it up here.

Let's fire it up. Got a, got a kind of a cold and rainy afternoon here in, in Los Angeles.

So what better to do than to have a Felix webinar on a weighted average cost of capital.

So this is the, I believe it's the eighth, seventh, or eighth session.

And we are eighth. Yes, we are.

Moving quickly through the valuation, again, I'm your instructor, Chris Cordone. I've got Yolanda Wadowski here is my teaching assistant.

And today we're going to put one of the building blocks in place for us to, to do the discounted cashflow valuation, which will be next week.

A lot of this stuff builds on top of each other, and even something like last week where we did trading comparables, it seems like it's kind of a standalone topic, but believe it or not, it's gonna creep back in again as we, as we move into valuation, into other valuation methodologies.

So, I'm gonna just, I try to mix things up as much as I can, try to adjust as an instructor, because particularly in this, in this particular format, it's really hard to know like where everybody is with things.

So, when I'm talking today, I'm gonna, put some questions out there, feel free to just, if you have an answer, put it in the chat, put it in the Q&A so that we can get some, a bit more collaboration.

Just feels, it just feels like we would all benefit from that also gives me a better sense, you know, kind of where we are.

So, when I think of weighted average cost of capital, I remember from back, going back to my own training it was certainly something that seemed very kind of theoretical and very academic, and I wasn't exactly sure what they were talking about.

I mean, I could understand the the explanation.

I know what it was referring to.

I had enough of a finance background at that point to, to piece it together.

But, you know, I still sort of thought about this, this term, weighted average cost of capital.

How do we think about it? What is it, you know, what is the weighted average cost of capital? What are we doing with it? Well, obviously one of the things that we need to do a discounted cash flow is to have a rate to discount the cash flow is back at, right? It's a concept of time, value of money. What is that rate? So the dis the weighted average cost of capital is often then referred to as a discount rate.

But, but that's really just a math thing, right? So, what is discounted cashflow? Excuse me, what is the weighted average cost of cashflow? What is the discount rate? What are we doing with it? Why do we need it? And what does it measure? Those are the kinds of things that we're gonna talk about today.

Obviously, we're gonna talk about how to calculate it, but I'd like to kind of get away from that a little bit and talk more about just in general, what it represents.

So cost of capital, what is, may I ask you all, what is the cost of capital? What does that mean? What is the cost of capital? Anyone want to lob a chat in or Q&A in? I'm gonna switch over to PowerPoint, put some notes down.

Anybody offer anybody offer one up.

Has anyone, has anyone done a weighted average cost of capital calculation here? Anything come through? I was switching away here.

All my, In the chat, somebody's, thank you, max. Yeah, What's Max? Hey, max, thank you, max. You've done a weighted average cost of capital and, I'm assuming, max dID you do it in the context of a DCF? Yes. Great.

So at least he, you know, he was on the right track, right? I mean, somebody told, so somebody taught him correctly doing a DCF.

You need to come up with a rate to discount your eventual cash flows, which we'll calculate next week, back at, so what does that cost of capital measure then? What are we trying to measure, max, that could be you or somebody else Risks.

Yes. Now we have a Q&A and a response there from risks.

Now you, now you put it in plural.

Now, if that were me, it might've just been, because I, I'm very bad typer, but, but I'm thinking for you, you might've had multiple risks.

Multiple risks, potentially. Are there multiple risks? And what, what are the risks that we're talking about here? Anyone, anyone? Well, you know, the issue here is that what we're gonna see, think back to our session last week on multiples, and I was very adamant that whatever, whenever we create a multiple, we have to make sure that we match the cash flow and the value, the driver and the value driver.

Now Max has chimed in here that he's refining this, calling it the opportunity cost of the capital as well as the risk of counterparty performance.

So that's, that's definitely a refinement there.

Opportunity cost of capital would imply that if you're investing in the debt or the equity of this enterprise, that there is a cost to you to put, to put your money there versus another investment, right? So what is the cost to put your money there versus another investment? And sometimes that is referred to as a hurdle rate because you have to kind of get over a rate that you can get for your dollars or whatever currency you're in somewhere else.

You need to get over that hurdle before you can actually, you start to consider this a valid investment.

So if I know I can get 10%, let's say in the stock market, then if I'm considering another investment, I'd have to, I'd have to kind of think about that as my hurdle rate. Now, I'd also have to think about, well, what's the risk of investing in the stock market versus the risk of investing in this other thing? Because the, because the risks are not commensurate, and a venture capital equity investment is different than an Apple stock equity investment.

So if my hurdle rate as an investor is, okay, I've got a financial advisor, he guarantees me kind of, let's say 12% a year.

So I don't entertain any other investment unless I can get 12%.

That's my opportunity cost, that's my hurdle rate.

Well, that's great, that's fine.

You can look at it that way.

But if somebody comes along and says, I have an investment for you, it's in a startup, it's in, you know, it's got these backers and it's got this going for it obviously my assessment of that investment's return is going to be separate from the stock market investment.

It's go, it's going to be based on how I assess the risk of that particular new venture.

So if we go back and we think about last week when I said, okay, we had EV to EBIT, and I said that the value driver has to be, has to match the value.

So when we get to free cash flows discounted cash flow, what we're effectively trying to do is we're trying to, we're trying to measure the free cash flows that are generated by this enterprise as a whole, right? And because the enterprise is the, is the combination of the debt and the equity at this point, and there could be other stakeholders too, but, but let's just focus on, on the debt and the equity as the stakeholders.

We have to figure out, what is the risk for each of these stakeholders to have a piece of that enterprise.

So there's a couple of components in there. It's like, what is the risk? And then what is the piece, right? How much of this investment do they have? And effectively, you know, what the, what the weighted average cost of capital does in a very basic level is it looks at, measuring what is the the desired return to the debt holder in this enterprise? We'll call that case of d times the percentage of debt.

How much of that ev do they have plus the desired return by the equity holder times the percentage of equity.

And that's effectively what the weighted average cost of capital is.

So we have an enterprise, you're considering making a loan to it.

How are you going to figure out what your return is on that, on that loan? Well, you're gonna do an assessment, a credit assessment, so to speak, and we're gonna figure out what we think we would want to get as a return on this loan.

What is our assessment of the riskiness of this loan? So that, that's kind of I think pretty straightforward.

And then also as an equity investor, what is the equity return that I would want to get from making this kind of equity investment residual, higher risk investment, obviously.

And, and then we'll figure out what percentage of the capital structure that's going to be.

And that, in effect is the waiting part of it.

And there's your WACC. So in theory, it's kind of not, not that hard to think about if we kind of bring it back to that original sort of definition of what, of what we're valuing here, right? So the cost of capital here is the cost of having these two different types of investments in the firm.

So you can look at that from both an issuer's perspective, and you can look at it from an investor's perspective, right? When a company thinks about what the cost of capital is, they have to think about what is it going to get what is it going to cost me to get a debt investor to lend money? What does that cost? The interest rate, generally right now, from the equity perspective, it's a little bit more opaque, right? It's a little bit more obscure because we have to think about, you know, some other factors.

What are some measures of return in, in the world of finance? What are some, what are some measures of return that we can, that we can think about? All right, Shelby, risk the risk-free return. Very good.

What else? What else do we have? World of returns. There used to be a slide on this in one of our decks, got the market return, okay? So we've got the risk-free, and that of course, only really available to a few, to a few kind of entities, right? The risk-free rate would be, you know, perhaps, you know, like the US government or you know, Germany, there's only a kind of a handful of them, right? So that's essentially a rate that only reflects more or less kind of inflation ish kinds of things, right? Reflects kind of zero risk, but there still is a, there still kind of a cost there, which is inflation.

Now, at one point we did have 0% rates because at the time we didn't, we had no inflation, and there was considered to be sort of no risk.

Now, things have changed quite a bit, reflect, reflection of zero risk.

Another, another chime in here from Shelby who said market risk as well.

So the market return.

So the market return that is another kind of return.

And I'm assuming you mean stock market here.

So that would be kind of something like an S&P return perhaps, or there's a number of them, right? Russell 2000, if you're into kind of medium, medium cap, and this would be sort of an overall return to the market.

Now, let me just drill down on that one for a second, if I could.

What is that the measure of though? What is that the measure of the market return in, in any of these, whether it's S&P or whatever. What I mean, how are they calculating? I don't wanna formula, I just mean like, what are they looking at? What is the, what is the return itself? Well, obviously we're looking at equity return, so that's an equity return or an equity rate, an equity yield you might wanna call it.

And it's effectively measuring the stock's performance, multiple stocks performance over, you know, a period of time.

So that's certainly one way that we can start thinking about, about equity return, right? Is to look at, you know, a market.

What other measurements of return are there? Have you heard about, there's even some ratios that have that kind of in it, you know, have that term in it.

ROIC, very good.

ROIC stands for the return on invested capital.

Excellent, excellent. So ROIC is a little bit different, right? Let's think about what ROIC represents.

What is all the capital that's been invested in the company? And let's figure out what the profits are to those investors.

So in a way that sounds a lot like kind of what the weighted average cost of capital here, isn't it? So the definition of ROIC and, you know, some of these things can be done a few different ways.

I've seen it done a few different ways.

I've seen it done with NOPAT over invested capital, and we haven't done a lot with NOPAT yet. We're gonna do more with it.

But that stands for net operating profit after tax.

It's basically the EBIT after tax over the invested capital, which is effectively the enterprise value.

So no pat over the invested capital or EBIT after tax.

And we're tax adjusting it. Because what we're basically saying here is that regardless of what kind of stakeholder you are, debt or equity, nobody gets their money until the government gets theirs.

So when we look at, EV to EBIT, which is a metric that we said was know, it was pure, it was righteous, right? It's like enterprise value and EBIT and you know, it's the right value and the right value driver, and this is what you wanna do.

'cause it's not impacted by capital structure.

It's that's the one.

Well ROICs been around for a long time, and ROIC is actually in a way a little bit more accurate because EV to EBIT certainly is helpful in a lot of ways.

And EBIT itself is a very clean and helpful metric.

But it does leave the concept of taxes on the table.

And the reality is that the taxes are gonna come out before any stakeholder gets paid.

So while it's understandable that the interest that inconvenient I, in EBIT is going to affect my taxes paid because it's a tax shield, it shouldn't therefore mislead me and make me think that I can just ignore taxes.

So in reality, this ROIC return on invested capital is kind of the, the, the true EV to EBIT in in a lot of ways.

Now, this is expressed as a percentage, not as a multiple.

When you take a multiple and you invert it, you get an actual percentage, right? So if I take, you know, if I take EV to EBIT, if it's 10 times, and then if I invert it, then it's, what it's basically saying is that by EBIT over EV is 10%.

So that's kind of similar to what the ROIC is.

Now, I'm going through all this because, you know, I was talking to Yolanda before class.

I really think that, you know, a lot of the math behind weighted average cost of capital is either very easy, very kind of not easy, but you know, it's not that complicated once you have the formulas and all that.

I feel that understanding what what WAC really is saying is more important.

And also, by the way, how do we check it? How do we sense check it? This goes back to what I was talking about with modeling, right? As, as analysts and associates we're responsible for these numbers, how do we, how do we know? I was recently asked to tutor a partner at a very prominent firm.

And now why, why would a partner need tutoring? I mean, I'm the one that needs tutoring, relative to the partner, right? You tell me how, how do you, how did you get there? You tell me., But actually it's just situation of somebody coming from one area of a firm to another.

And, this happens all the time, or coming from a law firm, a partner in a law firm wants to make the jump and be, and, and get on the buy side or whatever.

And so they're like, Hey I get this stuff, but I'm in meetings and I'm hearing people talk about, you know, we'll get pitched by an investment bank and they'll talk about weighted average cost of capital.

Or someone will say, well, that can't be right.

Explain this to me. And it's like, I want to know when I hear a number or when I hear a statistic, I want to know if it's right.

I want to have that, that gut feeling about numbers.

And you get them certainly if you work with them a lot, and most people by that point in their career do, unless you've come from somewhere else, and then you don't.

So a lot of people need to understand these numbers on different levels.

So I want to talk around this topic in that way.

So I, I like that ROIC was, was brought in here.

So thank you for that, Shelby.

And what we've got now is another kind of take, because if my EV to EBIT, or my notepad to EV is effectively my ROIC, then my ROIC is almost in a way like a cost of capital, right? Like a blended cost of capital.

That's effectively what this ROIC is.

Now, one thing that the, um, that the, the ROIC does not do is, what, what does the ROIC does not do? What does the ROIC not do? Same thing, by the way.

If I took, if I ran my multiples and I came up with EV to EBIT, and I inverted it, and I got effectively the inversion, the percentage form that 10%, somebody could say, well, that's kind of like the WACC, right? It's kind of like the WACC, and it is kind of like the WACC the same way that the ROIC is kind of like the WACC it is a blended cost of capital.

However, it does not reflect it does not reflect any weighting for the debt and the equity, right? It doesn't reflect any capital structure.

It's kind of just mixed all together.

So we don't, we don't really know who gets what.

We just know that it's, it's just kind of all, all in there.

So if the company was, for example, if the company was, for example, very heavily levered or very, or unlevered, it should kind of come out in the figure because it would come out hopefully at one point.

But we don't get that, that blending.

So ROIC is something we'll come back to and we'll, we'll use it kind of as a check on the numbers for sure.

Another thing about ROIC is that it tends to kind of be backward looking, and we really want to be more forward looking whenever we're doing valuation.

So you can, if you do a forecast, if we build a model, we can look at a forward ROIC for sure.

but in general, the again, it's still, it's something that we're gonna want to kind of take one step further, one step beyond.

So, we talked about risk-free rate, risk, market return, equity return, equity yield, ROIC, return on equity then would be kind of another return, right? Return on equity, of course, just looking at what the returns are to the, those residual stakeholders.

So that's the net income over the equity investment.

And in a way, again, that's kind of like, kind of like the price to earnings ratio, right? The price to earnings ratio is the opposite of that.

The PE is the equity value over the net income.

So again, inverting a multiple gives you a yield.

Now, if you've ever done an ROE calculation in your models, obviously you're looking at book value of equity, right? So usually if this is done, you know, within a financial forecast, we're looking at book value of equity.

So we have to ask ourselves, do we want book value or do we want market value book value, or do we want market value? Now, obviously, the price to earnings ratio is a market value multiple, and we can invert that and get effectively a market value return on equity.

Now, historically, again, if you crack open finance books, accounting books, they're gonna calculate the return on equity based on the book value, the equity.

And that's just kind of, you know, it's just kind of misleading for that purpose.

And it's the same, same problem in here.

We've got a book value situation going on, and as we know, we stepped into the world of valuation, book value is not really happening anymore now, and if you're doing banks and financial institutions, it's a little bit different, but certainly not the case with non-financial institutions.

So book value and market value is something we would have to question.

So, couple of things about WAC that we have to kind of make sure that we have in place.

First of all, we have to make sure that when we are doing WACC, that we are always using market values.

So that's going to impact how we weight the capital structure because it's debt to equity, but it's not book value of debt to equity.

It's market value of debt to equity.

So we must use market values.

We also have to make sure, we have to also make sure that, that this is the risk of investing in the entire business.

So it's an enterprise value risk.

The kind of related to that, the next two are kind of, kind of related to that.

It must reflect all of the capital items.

So anything in the capital structure really has to be factored into the WACC.

Now in general, we're primarily gonna do this for debt and equity, but we have to take into consideration if a company has excess cash.

We have to really think about that impact, On here as well.

So think about that.

And obviously if there are other components of the capital structure as well, such as, you know, preferred, so it must reflect all of the capital items, and as such, it has to be consistent with the cash flows that we are going to discount.

So, that kind of, to me, like two, three and four, are very, all kind of connected in a way because you've got that, you've isolated that box, that's the EV.

So obviously we're measuring the risk of investing in that ev well, the cash flows that we're forecasting, which we'll do next week, those must be generated by tha EV they've gotta be only enterprise value.

Cash flows, no equity cash flows, no debt cash flows, right? No non-core at cash flows. Technically, technically speaking, no non-core, no non, traditional business cash flows, right? So all these things are kind of, related in that sense.

So let's just to kind of get it on the paper really quick, take a look over at the workout problems.

Again, these are in, uh, the section on, um, wac, which is for November 15th, this workout, empty file workout, empty.

And just to again, get it kind of on the page here, we've got, uh, a given cost of equity, we've got a given cost of debt, not done kind of breaking those down yet.

But just so that we can kind of, um, see, uh, how this would work mathematically for those who are new to it.

We've got the value first.

It's asking us for, since we have the costs of debt and equity, it's asking us for the waiting.

And what we've been given here are, as we know, since we're doing a WAC calculation, market values of debt and equity.

So what is the value of debt relative to the debt and equity? That's gonna be the, uh, for the debt, the 500 over the 500 plus two 50.

And that's telling me that I've got, uh, roughly two thirds debt, and then the equity, of course, we can just kind of cut to the chase here.

And do you know, one, uh, one minus that? 'cause it's gotta add up to a hundred, uh, or we could do the equity value over the sum of these two, either or.

And so now I can calculate my whack.

So I've got everything in place.

Now you'll notice that there's a, there's this kind of added assumption here for tax rate.

How is this gonna come into play? Well, if we think about, remember I said taxes are very important because we can't really consider any cash flows to stakeholders until we factor in the, the taxes.

Well, if you're looking at debt financing, from an issuer's perspective, the cost of issuing debt is actually less than the face value, uh, of, of the rate, because you get a tax shield on that.

If you're looking at investing in debt, the return to you as an investor is going to be less than face value.

'cause you have to pay tax on your anticipated returns or yield or however you wanna look at it.

So in order for us to figure out what a true cost of debt is, we have to do it post-tax.

So I'm gonna take my pre-tax cost of debt, and I'm gonna multiply it by one minus the marginal tax rate.

And what that's basically saying is, I want the after-tax number.

So actually, let me just do that kind of off to the side so we can see it.

And you know, that's just basically saying that it's 3.8%.

So the true cost of that debt, a little bit cheaper to the issuer because of the tax break, 3.8% cost of, um, equity.

Well, that doesn't get a tax break, does it? So we know that that's going to, that's gonna be fine.

So what I'll do is I'll take this after tax cost of debt, and I will multiply it by my debt as a percentage of the capital structure, and that's gonna give me my weighting of the debt cost.

And we can see here that if I just kind of quit there, that this particular capital structure is weighted toward a debt return, is weighted toward debt because of the high percentage of debt in the capital structure.

So 3.8 is the debt cost after tax, and 2.5 of it is getting into the WAC total because of that weighting.

And now I'm also gonna take the equity return and multiply that times the weighting of 33%, and that obviously lowers that equity return.

So it's one third of 10%.

And obviously that's got a big impact on, on the number because if this were more equity rate, uh, weighted, if the, uh, equity value, let's just say we're, you know, 1250, if it were more weighted toward equity, that's gonna pull the cost of capital way up because we're weight the higher cost of capital, we're weighting the higher risk cash flow, and that's going to impact the overall riskiness of how we measure this.

So where, you know, where are we getting these from? Where are we getting these percentages from? Well, you know, I, if I go back to the slides for a moment, and I think about this enterprise value, as you know, as it currently stands, we know that it's supported by some level of debt and equity.

So here come kind of all the complications to this right? Here, come all the complications, because again, on the surface, the math is not that complicated.

Well, we don't, we don't really know if we're buying a company, we don't really know how we're going to capitalize it.

Remember, the capital structure and the value are completely detached, right? We, we talked about this probably a couple weeks ago now, or maybe it was last week.

We'll go back to the houses, right? One house has been owned for a very long time.

The owners have paid down the mortgage, lots of equity, same house next door, just just purchased a couple of years ago, has a lot of debt.

Both houses go on the market, they're gonna ask the same price, right? They're not going to alter their asking price based on which house has built up more equity.

It doesn't matter. The house is worth what it's worth.

So the next buyer has the decision of how they want to capitalize this company.

So we're looking at future value, right? Future valuation.

How do we determine, how do we determine what the capital structure should be going forward? Any ideas? How do we determine what this blend of debt versus equity should be going forward? We're not taking it from the current balance sheet.

That's, that's, um, one thing that I will throw out, uh, Fiona, Fiona has suggested we benchmark with the peers.

So yeah, we could totally do that.

We can look and see across the industry what is the approximate level of leverage that is used Now, I mean, who says that's right? You know, it, it, it, it might, it might or might not be, but generally, you know, there's safety in numbers, right? So if we have a good peer set, we have a good industry data set, and we can look and see, you know, what is, um, you know, the rest of the, the industry doing.

Now, if I, I have a good, uh, I have a good little data set on that, and from the slide deck that I would just pull in.

Yeah, here it is. I'll just pull this in.

So here's one, uh, this is old, so it's not, not really relevant, but here is, um, this is in the slides, which you, which, uh, which you, you have, I believe, um, the food processing, uh, uh, business, you know, kind of looks like this.

We've got some, some, you know, some big companies in there.

And you know, what we see here is that generally they're kind of capitalized in the, you know, 20% debt to capital.

But if we look at ConAgra, ConAgra is an outlier at at 30%.

They're very heavily levered relative to others.

Danone's a a little bit higher, but you know, generally it should be a little bit on the lower side.

Now, does that mean that ConAgra's doing something wrong? No. Well, we have no idea what ConAgra just did. They just bought somebody, they just built out infrastructure.

We have no idea what they did.

So we're not penalizing ConAgra, but we're just trying to do kind of an analysis of how we would break ConAgra's business down. If we were to buy ConAgra and recapitalize the company, what would it look more like? Well, knowing that it's within this industry, it'll probably look like more in the 20 to 80 range debt to equity debt versus equity.

So that's gonna be how we weight this.

Now, it is possible, um, you know, this, uh, by, by the way, is what we would call kind of a target capital structure.

It is possible to come up with a target capital structure without looking at comparables.

Um, you know, you, you, you could look at other things as well.

It could just be, um, how the company envisions itself being valued or being, uh, being capitalized, you know, in the future.

But regardless, it, it doesn't have to be, it may not be where the company is currently capitalized.

So that's the concept of the target capital structure.

And that's, um, you know, I think that that's, you know, pretty, um, you know, I think it's pretty, uh, uh, you know, straightforward, especially if you have, you know, a decent data set. And we have, there's a lot of data, you know, on, on Felix, which I'm, we're gonna try and do a Felix case to wrap up today.

Again, just trying to mix things up a little bit.

Um, so, um, let's see what the next question is, if I can skip into that.

Um, I think the next thing I want to do is kind of move into more about what comp, what, uh, how these rates kind of break down the cost of debt and the cost of equity.

Um, you know, generally we don't spend a lot of time, uh, on the cost of debt because it's, um, you know, it's, it's a little bit easier to, to figure out.

Um, I'm gonna just go over a couple of caveats that I, that I'm aware of, you know, with cost of debt. And if anybody else, you know, has any, they're welcome to, you know, chime in.

But we mentioned that this has to be, uh, after tax.

Um, we also have to be careful with the cost of debt to make sure that, um, well, let, let me ask you, where would you find the cost of debt? Does anybody, if anyone who's done this, I know Max, you said you did one.

Um, where would you find the cost of debt for a company? Is it published somewhere? Can you, you know, so Max says, okay, well it's got the risk-free rate, the risk-free rate, of course, would tell us, um, what a risk-free entity.

And then you would add to it something from the f the A financing curve, a, a a a, a, A rate curve, whether it's, uh, FR or, or, uh, um, or you could use a, a European rate as well. They're still using, I think Yuri bore over there, sfr a URI bore.

Um, and how would you assess, uh, the, the, that curve, max? I mean, what would you do with that curve? I mean, the curve basically is gonna tell you, it tells you a lot of things, right? Tells you which way the rates are heading.

But how do you pick something on that curve? There's a couple, you say match the tenors.

So basically what we have to do here is the, we have to look at, um, companies can borrow a number of different ways, right? They can borrow short term, they can borrow long term.

So what we're looking for is essentially, um, a rate that kind of matches the task that we're trying to do, which is to value the company.

Generally, valuations are, are longer term in nature.

So we don't use short term rates.

We generally are going to use longer term rates.

So we're gonna start with a risk free rate, and then we're gonna add to it, you know, some kind of spread.

And that spread is going to be, uh, you know, effectively, uh, based on, um, the credit, uh, profile of the company.

So the risk-free rate might be a treasury, it might be the overnight funds rate.

It's a, it's what you call a benchmark.

And then we add to it the spread over that, and the spread over that is based on, uh, the credit risk of the borrower.

Now, that part of the analysis, um, may be easier.

May it's a publicly rated company, probably not. So, not so hard to do. We find a credit rating, we find a a, a curve, um, and we figure out what is the spread, what is the appropriate spread for a triple B company? What is the appropriate spread for an A company or a double B company? And that's, um, that's generally how we do it.

Um, and so we're gonna need, uh, a company rating as well.

And we want a longer term, uh, a longer term financing rate.

What would that be? Well, probably somewhere, you know, in the, in the 10 year range, you know, five to 10 year range probably.

Now there's one thing, uh, does anybody else have any other ideas of what you could do to find, to find the cost of debt for a company? Where else might I look up a cost of debt for a company? Eight K? Yeah, great. That's a great answer.

So if I were to go into, and I think last time, um, or one of these, I was, you know, using, um, home Depot a lot because they borrow a lot, right? Um, if I look at Home Depot and I go into their 10 k, that's where there's more data in the 10 K, which is why I'm going there.

I don't want an extract. They kind of just need the whole thing.

'cause the extract isn't gonna be good enough.

And I go over to the sections, go to the debt and derivative instruments, and I go and look at, so Shelby, did I just, did I just get into a gigantic mess here? Or what? Um, I go, oh, all of these, all of these, uh, issues, they've all got a variety of different rates.

I guess if I, if I could get a download of these, which, which, you know, you, you young folks can do very easily.

Now, when I was, you know, an analyst, everything was kind of by hand.

You, you could spread this and weight it and maybe wait the rates or something like that.

Um, the caution here is that this is a very, you know, very pragmatic way to, to look at it.

And in some cases you might have to just go to the, to the 10 K and, and try and find out what their borrowings are if they don't have any public, public, um, debt and, and no rating.

But the issue here is that a lot of these rates are outdated because they were issued 5, 10, 15, 20 years ago when, when the market was in a different place.

So if we start waiting and, and calculating a cost of debt based on, you know, a 10 k or a recent filing, there's a very good chance we could miss the boat on what their true cost of debt is, because their true cost of debt has to be measured kind of as of today.

Because if you're an investor and you're looking at the cost of capital of investing in this deal today, well, that's what the capital costs.

It's what it costs today.

So that's a caveat here that we wanna make sure that we, that we, um, don't rely too much on perhaps outdated, um, outdated, uh, rates.

So I'll put that in here.

Avoid older term debt or just really older debt, I guess.

Just avoid older debt with, uh, outdated cost of borrowing.

Um, and then pretty much, you know, once you, um, you know, once you, once you do that, um, you know, it's, it's pretty much done.

Um, I will say one, one last thing, which isn't so much about the cost of debt, but it does have to do with the, uh, the blend of, of, um, of debt and equity in the capital structure.

If you're using a target capital structure, this is totally irrelevant.

But if your, if your starting point is how much debt or equity is in the current capital structure, and sometimes that is a starting point, we want to be careful that we're, you know, we're, if we're using the market value of equity, we wanna make sure we're also using the market value of debt as well, right? So market value of debt for, um, for waiting, put that in parentheses.

'cause it's not really a cost of debt issue, it's more of a waiting issue, okay? So, all right, this is easy cost of debt, as I always like to say. It looks like I'm getting going home at eight o'clock tonight.

And then, somebody flips the switch and says, now let's talk about the, cost of equity.

Let's talk about the cost of equity.

How would we re do, how would we determine the cost of equity for a company, right? How would we determine the cost of equity for a particular company? What is the risk of owning a stock? What is the risk of owning the stock of this company? So, you know, we can go back, you know, to that original conversation and look at, you know, the return on equity.

We could look at the price to earnings ratio, the multiple, and then we could maybe even invert it and take a yield.

We, we could in theory, you know, do all of that.

Some of that, you know, kind of leaves, a little bit kind of it leaves us open.

It le exposes us, right? If we think about what goes into a price to earnings ratio, right? If I'm gonna take a price to earnings ratio, and I'm going to invert it to get the yield on the equity, then I shouldn't say equals, I should say goes, becomes, to get the yield on the equity.

Well, the price to earnings ratio is the current market price.

That's good, but it's also the current earnings, it's not forward earnings.

It's also can be forward earnings. It could be forward year one.

Most PEs are done off of forward multiples, but it also depends kind of on, you know, what's, what's happened.

You know, in that recent period, from an earnings perspective, it could be a bad period.

It'd be perhaps if we've normalized the earnings, it gets us a little bit closer.

So there can be some static in this number, there can definitely be some static in this number and the price.

So I'll put static and then the price might also have some static.

What kind of static could be in the price on a particular day? What static could be in the price? What's going on right now? What's going on right now, right? We've got earnings calls, right? Could be an earnings call, could be, it could be m and a activity.

So, you know, this is, it leaves this open, leaves this, it leaves this open to some potential one-off things that we wanna, we wanna be careful of.

So that being said, how could I determine what my hurdle rate is? What my assessed risk is for investing in equity? Shelby's all over it.

Risk-free plus beta times the market return, minus the risk-free.

Max says you want, max is like betas too.

So, it looks like the smart money's on, on betas here.

Everyone wants to come, come back to betas.

So Shelby's saying that there's a there is a formula for this, for us to figure this out.

Now, if we just think about what we did with the, the cost of debt, we started with a risk-free rate.

Almost everything in the world starts with a risk-free rate.

I just did a presentation on private debt, and the way I explained how the private capital, private credit world builds up rates outside of the traditional banking system is, you start with a risk-free rate, you add a spread, and then you start adding in all of these other kind of risk factors, right? Is there a sponsor involved? Is it a high cap company or is it a mid cap company, right? Is it senior? Is it junior? So you start adding it, but everything starts with risk-free.

So just like building up the cost of debt, we're gonna start with the risk-free rate, and that's often denoted by rf, capital R, lowercase rf, the risk-free rate.

Now here, we don't have, we do not have a credit rating to go on. We don't say, well, apple fits into this category, so Apple's stock should return in this range, and there's none of that, right? It's basically equity sort of like, it's the, this is what's left over. These are the spoils of war, was the term I'm kinda looking for.

There's no cap on it. So we can't really do it. We can't put companies into buckets and say, this is what you should return, this is what you should return.

It's really up to them to generate as much as they can.

So we have to figure out what a formula is going to be to, you know, effectively calculate this.

And so if you invest in the stock market you invest in the stock market, then you are expecting a certain amount of return for that equity risk.

If you were to invest in the entire stock market, then that would be obviously a very diversified portfolio.

You would be diversifying your investment, you would be lowering the overall risk, and you would be taking kind of an average return on the market itself.

So we, we can do is we can start thinking about, okay, well what is in effect my reward for, for investing in the stock market? Well, we have a market return, and that market return includes, like everything else, a risk-free component.

That's the basis of every rate.

So we've got the risk-free rate is baked into this.

And the difference between these two is what's called the market risk premium.

So the market risk premium allows us to assess how much greater than the risk-free rate is the return to, to invest in equities.

So that's very important here, because now we've got a way to kind of build up this, you know, this sort of this sort of end of the of investing.

So I've got the risk-free rate, and then I'm gonna add to that the market risk premium.

So now the problem is, is that I'm not investing in the whole market.

I'm not investing in the whole market.

I'm investing in one particular stock, one particular equity.

So the market risk premium has to be adjusted to reflect this particular investment.

And that's where this concept of, of beta comes in.

And, you know, again, it gets, it just keeps, seems like it keeps getting headier and headier more academic.

As we go, and I often say about DCF before we begin, normally I start DCF first, and then I kind of go into whack and go into cash flows and go into terminal val but because of the nature of these sessions, I'm kind of frontloading it with whack.

But the free cash flow DCF analysis is, is one assumption based on top of another, on top of another. It's, it's a house of cards in a way.

That fortunately, it's been built up by some very smart people who have done a lot of research into this, but there's a lot of assumptions here.

So the concept of beta is, is what's going to help us adjust this market risk premium to make it more equivalent to, to the risk of investing only in this one particular stock.

So the market risk premium times the beta, and again, that's gonna be the risk of this particular stock or equity.

Okay? So the beta then opens up a whole other kind of can of worms.

But first, before we do that, let's just kind of get this again into our, into our, into our bones and go over to the workouts.

And let's skip down to let's skip down to workout number.

Let's see, workout four has got beta in here.

Let's see, let's work, let's do workout number five.

Let's do workout number five.

So, here we've got all the components that we've talked about so far. Lemme just make this a tadd bit bigger.

We've got a risk-free rate, right? The 10 year government bond, that's our risk-free rebate. And, and Rayon noticed that we did match the tenor here is 10 years.

So we we're kind of in that sweet spot that we're looking for.

We've got the equity estimated equity risk premium, and again, that's that market return effectively, market return less the risk-free.

And then we've got beta, we've got 1.1, and then we've got cost of debt, 5% in a tax rate.

So before we can do the problem, I feel like I just want to, I'm not gonna spend a lot. We never calculate beta. You might calculate beta if you're in a particularly quantitative AR area, but what we're, we we're basically saying that beta is here. If we think about this formula, right, of risk-free plus beta times the market risk premium, the market risk premium, or the equity risk premium, I'll call it the equity risk premium here, since that's what it's being, referred to here.

If we think about that formula, beta's acting here as a multiplier, and what we're basically saying is, okay, I've got a particular equity, a particular stock.

And what I'm saying is, is that that stock is, that stock has a riskiness that is inherent to that stock alone.

It acts as a multiplier to the equity risk premium in, in that way.

So the beta just make this formula a little bit.

The beta here at 1.1 is effectively saying that this stock is riskier than the market itself.

So effectively what we do is we look at we look at kind of, you know, the, the returns

of the market, and it's just all these data points like this.

And then you, you calculate the correlation between this particular stock and the market.

And then we get this kind of like line in here that tells us sort of where that stock is relative to the performance of the market as a whole.

And that's effectively kind of what beta is measuring, it's measuring that relationship.

So if it's exactly one, then it's the market.

You're basically saying that that stock mimics even in its own little tiny way, the risk of the entire market, that there's no more or no less.

It's about one.

And if it's greater than, than what you're saying is that that is greater than the risk of the market, and then less than is less than the risk of a market of the market.

So a beta of 1.1 is greater than the risk of the market.

A beta of less than one is less than the risk of a market of the market.

So in this example, we have a company with a beta of 1.1.

So we would expect that to have an incremental effect on the equity risk overall.

And that's what this formula here is going to do.

So my cost of equity is going to be my risk-free rate, plus my equity risk premium times the beta.

And I always joke with Yolanda about how they can't format our spread, our, our spreadsheets for us.

We always have to do that last little bit.

So my cost of equity here is at 8.6%, and effectively we can see that the market return is what is 8%, the market return is 8%, but we need more than that for this stock.

We need a little bit more than that.

And therefore, to invest in this stock, the calculated return is 8.6%.

Now, as Shelby has correctly pointed out, what we've just done here is we've calculated what's called the capital asset pricing model.

And that's effectively kinda what, what this is, this is the capital asset pricing model, and that makes you feel smart, you know, to be able to walk around and say that you know, you cap M

and then you realize that everyone kind of knows it.

now if you know Black Shoals, that's, that's a good one, that's a good one to know.

If you know, like Mac Lee duration, like that's a good one to know.

CAPM is, is actually the way we've distilled it down I think if you understand it in this way, you get a lot more out of it than, than, you know, just kind of formulaically trying to figure it out.

So you just outta curiosity, lemme just finish this problem.

Cost of debt after tax, that's gonna be, the 5% times one minus the marginal tax rate of 25%.

Once again, I will be formatting this and that gives me 3.8, and now I get to blend it out.

So here I've got, I've been given the, the percentage in the notice it says target capital structure.

So this is like a nice kinda layup. The problem here.

I'm gonna take my equity cost of cost of equity at 8.6%, multiply it by 70%, and I'm gonna add that to the 3.8% and multiply that by the 30%, and that gives me a weighted average cost of capital of 7.1%.

All right, any questions on that? Still got a little bit more to kind of dig into here with, sorry, my Excel slowed down.

That's weird formula.

Okay. There's that formula. Okay.

So as I've mentioned, you're, you're probably not going to, you're probably not going to do a lot of beta calculating, has anybody here ever calculated beta? I mean, I don't mean lever and unlevered. We'll talk about that right now, but I mean, actually been given a bunch of, there's a problem like this later on which we're not gonna do. But you're, you were given the IBM price versus the market.

We have to find the, probably not, I don't know.

I don't know anybody. I mean, we have a colleague Humphrey who's probably for his own pleasure calculated beta, but Yolanda's laughing.

I joke whenever there's a, a problem that comes up that's involves a ridiculously complex Excel solution, we always go to Humphrey.

Because Humphrey wakes up with an equal sign in his head that's like his eyes open and then it goes equals and he's just ready to solve any problem.

That's so true.

So you're not, you're not probably gonna have to do this, but when, when would you have to do some calculations? Now, Max has mentioned in the Q&A this concept of industry betas and stuff like that.

What happens is particularly if you do, if you do any work with private companies or with private companies would probably be, Is that you often you have a beta in that beta, again, reflects the risk of that particular stock.

But it also reflects part of that risk of owning that stock, if you think about it, is how is that particular company capitalized? So again, if you own, if there's two different companies here and you own equity in this company, and then you look at this company, this company is a lot more risky, right? Because as an equity investor, you're, you're kind of getting pushed way down.

So that's going to impact the beta of a company.

Somebody asked me recently on a call, Or in a class, what was the highest beta I've ever seen? Do you know, I mean, do you, do you have an answer to that, Yolanda? Do you, can you recall one, 1.6 ish? I looked up 0.1 at crypto, Crypto crypto to the rescue? Yeah. And the beta for crypto was, was over two.

Wow. Over two times.

So that means it's twice, twice as risky as the market.

That just kind of gives you a sense.

Now, crypto's risk is not about debt, right? They actually, they're not horribly levered. Right? If I did, I'm trying to think of a company that is horribly levered right now that's drowning in debt.

I know rent the runway was in trouble, but I think it kind of got, I don't think it's got, I think it worked out. Yeah.

Yeah. I think it's the beta is, oh no, the data's not even here.

I think got worked out. Company that's got a ton of debt. Well, it work. Yeah.

Yeah. And that's, and that's problem too, right? So let's just look at that. That's a good one.

Their beta is still oh, their beta is, is still. Okay. Now we, I'm gonna go, go into, into what all these mean. These numbers adjusted beta, unlevered beta.

So, I don't actually have their raw beta here.

I have their, I have their kind of beta after they've been kind of adjusted.

So, effectively what I'm trying to say is that if somebody were to buy WeWork, they would restructure the whole company.

So their their equity stake is gonna be in a different position than one of these two situations here.

So a lot of times when we find, if I go back to that slide of ConAgra, if I were pulling all of the betas for these companies, I would expect ConAgra's beta. Now, this is a, this is old, so I don't, I don't wanna, I don't wanna risk looking foolish and pull up the betas right now, but I would expect that ConAgra's beta might be a little bit high.

If ConAgra's beta is high, then that's gonna make their cost of equity high, and that may not be an appropriate assessment of their cost of equity, because the cost of equity has been biased by a lot of debt in the capital structure.

And our target capital structure may look more like Campbell, which would lower the beta and lower the cost of equity.

So if I just pull, if I'm valuing ConAgra and I just pull their beta and plug it into the WACC, I am putting static in the number.

So what I want to do is I want to have this process to be able to assess beta on an unlevered basis.

So I want to take the capital structure impact out of beta.

So if I take the capital structure, so right now, the, the beta reflects the equity risk.

If I remove the capital structure from beta, this is what we would call beta levered.

If I remove the levering from beta, effectively what I get is what's called an asset beta, because I don't have any capital structure in it.

And now what I can do is I can take a more target capital structure, impose that on the numbers, and recalculate this so that I get something that we would call beta reverted or beta adjusted.

So that's kind of gonna be the process here.

We're going to take, we're gonna take unlevered beta, sorry, we're gonna take levered beta or raw beta, which is affected by capital structure.

By the way, this could go the other way.

You could be looking at a company that has zero debt, like Lululemon has no debt, so their beta is probably really low.

But for Lululemon to compete long-term as a company, they're gonna have to borrow and take some, you know, take over some other companies, right? They're gonna have to buy some people out. If they want to be standalone company, they're not gonna make it as a little, just a little outfit place.

And in a fancy mall, they gotta, they're gonna have to figure out a strategy to, to really compete and grow and do shoes and do whatever, right? So, I mean, who wants my opinion about that? But I mean, I'm just saying that longer term, Lululemon's gonna have debt to accomplish growth.

They're not gonna have no debt.

So, we take the levered beta, the raw beta, which is affected by the current capital structure.

And then we remove the impact of leverage.

We remove the impact of leverage, and that creates an asset beta that creates an asset beta.

So just kind of shift it over to the, to the, you know, the EV section.

Now, what we have to do is we have to rever beta using a target capital structure, and that's gonna create an adjusted beta, which we can use in our analysis.

Now that target capital structure max, that could be an industry beta, we could be looking at the industry for that.

We could do comps, we could do beta comp analysis and that kind of stuff.

I have seen done. So where this is helpful is in the situation that I've, that I've told you about with ConAgra.

And where it's also helpful, by the way, is, let's just say that I don't have a beta for a company.

I there isn't one.

So I wanna be very careful about just, I, the best comparable for the company might not have the best capital structure.

So I want to take a comparable beta, unlever it, relever it, and kind of get back again to a more realistic beta for the company.

Any, anybody have any, any questions on this? Yeah. Shelby, you jumped in with WeWork as well.

I've got two different chats going here, and Yolanda and my dog was barking at somebody at the door.

It's just like Armageddon here, okay, got the free, the, the got the freeways on fire means LA my God, LA oh boy.

And it's raining and it's raining today on top of everything else, you know? Okay. So, when I first moved to LA, there was, it was, you had to be careful not to get shot on the freeway.

Like that was the fur. There was like drive by shootings on the freeway.

Now, now they're just catching on fire.

So I think that's probably an improvement in some, in some ways.

Normally just the hills are on fire this time of year. Okay? There is a formula for this to do this to remove the impact of leverage.

There is a formula for this, and it's they're not that hard to to do. They're not crazy. They're, you know, they can't, they can be a little bit I've seen them a little bit more done, a little bit more complicated with the tax impact.

But effectively what we're gonna do here is we're gonna take the levered beta beta levered, right? That's the first step. And we're gonna divide it by one plus, one minus the tax rate, because we need to take the impact of the tax shield here times the debt over the equity.

And then I put, I just put all of that in parentheses. So the beta levered divided by one plus one minus the tax rate times the percentage of debt in the capital structure.

So that, that takes away the debt.

But it also kind of takes away the, the tax shield as well, right? So it's kind of doing it, doing it very systematically here.

And what that gives us is the asset beta or the beta unlevered.

And now I take my beta unlevered and I multiply it by the same formula, believe it or not.

I take one by one plus one minus the tax rate times the debt over equity, and that gives me my beta adjusted.

Now you might say, well wait a minute, and that if I just do it, if I do it, undo it and redo it. Isn't that doing the same thing? The key here is the D over E.

So you unlevered at the current capital structure.

So that removes the impact of the current leverage, and we need to know what the current leverage is so we can unwind it and unwind the tax impact.

And then we re-leverage it at the target capital structure, and that's what creates a different beta sound good? So let's take a look at the problem, and I want to just do one of these, and then I want to do, this Felix case, and I'm gonna show you where some things are on Felix, that could help you.

Things I've kind of feel like maybe I've skipped over a little bit, just trying to get everything done.

Okay? So let's go into this workout again and let's take a look at problem six.

So it's kind of the similar sort of setup here, similar setup, but effectively what what we've got is a situation where the beta that we've got reflects leverage.

That's 40 to 60 equity, or I should say 60 40 debt to equity.

And we intend to envision this company being capitalized at the opposite 60 40.

So just kind of off the top of our head, right? Again, just looking at these numbers, you're in a meeting and you're being asked to just kind of give a quick take on this.

If we have a existing raw beta of one seven, that's at a higher debt in the capital structure, and we're going to re-leverage it at a lower debt in the capital structure, which way is beta gonna go? Is beta gonna go up or beta gonna go down? Is my, is my adjusted beta gonna be higher or lower than yeah, it's gonna go, John jumped right in with lower.

Absolutely. It's gonna go lower, right? We're gonna remove some of the risk involved of owning this particular stock.

So I'll do it very quickly.

And then I want to, I want to do the, the next I wanna jump down to problem eight, because it's deals with industry betas.

I think it's a little bit more applicable.

So, I take my unlevered beta and take my 1.7, I'm gonna divide it by one plus, one minus tax rate times my current debt over equity.

And I, I can just use the percentages as they are because, it's fine.

And did I do that right? Let's see, wait a minute, sorry. My excel is slowed down, divided by one plus one, one minus, what did I do? C 5? I think it's C76. No. Oh, sorry. The yeah, Sorry.

my excel is, so my, when I'm in a, when I'm in a cursor, my cursor's moving.

I think it's where it should be and it's not.

So obviously when I strip all the leverage out, I get, I get a 0.8 that's really low, that's super low.

And now what I'm gonna do is I'm gonna say, well, that's not realistic either.

This is, that's l that's Lulu land.

Let's go back and put some debt on this.

So I'll take the 0.8 and I will multiply by one plus one plus one minus tax rate times the new debt and over equity.

And that brings the rele beta up to 1.2, which is, as John pointed out, definitely lower than before.

That's gonna have a pretty big impact.

So let's just see what that is.

Cost of debt it's gonna be the, the new cost of debt at 5%, right? Because this is the existing cost of debt in the old capital structure when there's a lot of debt and it was riskier to borrow, but in the new capital structure, it's not gonna be as risky to borrow.

So I wanna make sure I grab the 5% times one minus the tax rate.

There's my cost of debt, and then my cost of equity is going to be my risk-free rate plus the equity risk premium times the new re reliver beta.

And that gets me to 10.4.

And then I can do the blend, according to that second set of numbers there, 60% times the 10.4 and 3.8% times the 40%.

And that gets me to a cost of capital is 7.7%.

Okay? So kind of one, one formula, two formulas that you gotta really kind of know.

I think it's un levering dividing. I don't know, it just seems to always kind of work for me.

Because I'm think of dividing is making smaller, and un levering a beta is I mean, pretty much always gonna make it smaller.

I'm trying to think if there's an example.

I I know it has to, it has to always make it smaller and then vering, I guess in theory, yeah, I mean, I guess it could, it could be the same if there's no debt, but but I just, that's just kind of my own kind of mnemonic device for dividing first, then multiplying second.

Now, um, where, where we see this happen a lot is again, with private companies where you don't have a comp, you don't have a a a beta, and you need, you need one.

So I just quickly go down.

Let me just ask here, is there any are there any questions on, on the theory behind this? I know you're pro, you're probably saying, well, the only number you haven't talked about, what to get is like, where do you get that risk premium? Do I have to, you know, do I have to get it from the S&P? Do I have to do that calculation? That's the only number that I've kind of taken as a given, and I'm gonna go over that kind of in the small little case that we're gonna do at the end.

But for now, if there are no questions, I want to just show you this problem here with, a set of comparables and a company for which, we don't actually have a beta for.

So for for Univision, they don't have a beta, but we've got a series of com competitors that we can look to to figure out what, what kind of would the beta be for this company.

And because it's a, in the entertainment sector, and this is old, right? Really old, the leverage is all over the place.

And then you got like, Netflix is very highly levered.

Some other companies, you know, are not, I mean, Apple's technically, I guess in this racket now too.

But you know, so we don't really have a true comp.

We're gonna have to, we're gonna have to calculate it, right? cbs, Viacom, they've obviously merged.

Fox got bought by Disney.

So it's been a lot has happened since, since this was done.

But, doesn't matter, just an exercise.

So I'm gonna unle all of these. First, I'm gonna take my beta, that's the raw beta, the existing beta.

And I'm gonna divide by one plus, one minus.

I'm gonna come up here, I'm gonna anchor this, I'm gonna lock it because I'm just gonna copy this sucker down and we're gonna get outta here, you know, quickly won't, won't belabor this.

So I'm just adjusting by the tax rate times the, remember we always unle at the current, debt to equity, right? So now in this case, we've got, the market cap of the debt and the total debt market cap of the company and the total debt.

So we're using, obviously always want market values for this.

So this is another good, good example.

Always making sure in the other problems, it's kind of hard to tell, did you take the right number or not? Well, here we know market cap and total debt.

So I'm gonna take the debt over the equity and that's going to unle that.

And now I'm just gonna copy this down and I'm gonna get all of my unlevered betas, all of my unlevered betas there.

So my industry average is 1.1.

And now I need to rever that at what I think Unilever's, not Unilever.

Univision's gonna be going forward.

So here it's saying what is the unlevered Univision beta? Well, the unlevered univision Univision beta is the 1.1.

Because that's, that's the industry beta. We don't have a raw beta for them because they're not public.

And now I'm going to lever them.

So I'm gonna take the 1.1, multiply by one minus one, sorry, one plus one minus the, 35% tax rate.

Obviously this is pre-tax reform times the, I like doing this.

You don't need to use parentheses here, but it's easier for me to audit when I do use parentheses the debt over the equity.

And now I have a beta that I can use for a private company.

And that's that.

Any questions on that? Alright, cool. So what I'd like you to do now, I want to go to Felix and just look at some of the data and kind of break it up a little bit.

If we go over to the course syllabus, if we go over to the course syllabus, the next section on DCF has a DCF challenge here.

And there's two files here.

I don't, I don't know, quite honestly, if we'll get to actually finish the challenge next week, I'm gonna, I'm gonna try, but I really just wanted a more applied, exercise for, for WACC.

I just get tired of doing the workouts because they're like the, last one, they get old and, and I want to, I'm working with people who are on the job.

I wanna show you where you can get data from, right? So just download this DCF challenge, empty, you can download the handout too.

I'm not gonna spend a lot of time describing the situation. Just, I really just want the, the exercise.

So DCF challenge empty is what we're gonna use.

And that's going to be this file here.

And basically this file is valuing a company called ATI, which is a basic industrial type of company.

These are the best companies to value, which is really kind of nuts and bolts, even if you have no idea, you know, what, what it is that they do or the chemical or the thing. It's just like the thing that they make, you don't have to understand any of it. It's still, there's something about basic industries.

It's really kind of it's like the comfort food of the investment banking world.

And they do, there's a lot of deals in, in basic industries.

So you if you work there, you tend to work really hard and you get to see a lot of, a lot of stuff.

But, in general what we're gonna do here is if we go down to the next section, it's gonna ask us to calculate, the WACC.

And that's primarily what, what we care about doing here.

So first thing I'm gonna do is I'm gonna go over to Felix and I'm gonna pull up ATI manufacturer of specialty materials and components, blah, blah, blah.

We're not gonna get to do a lot of delving into this company, but we will get to look at some of the Felix data.

So the first thing it asks us for here to calculate the, let me get rid of this Home Depot.

The first thing it asks us for is some of the stuff that had been given to us quite a bit in the problem.

And that was the risk-free rate.

So on Felix we have this, and I'm sure you have it all over your, you know, all over your systems.

We want a 10 year government bond yield.

So this is a US company so I'm happy to take a treasury rate that's currently, 4.9%.

So there's my government bond yield.

Okay, now I need to get the equity risk premium.

So what is this again? Where am I gonna get it? Equity risk premium once again is just that what, what you get to on top of the risk-free rate to get the full market return.

So where can you find this? Well, generally you know, there's a few different places.

Has anybody ever had to look for the equity risk premium before or find it, Max, you said you did a DCF. Where did you get your equity risk premium, if I may ask? I think it was Max. Max.

It was a formula.

So assuming it was like from a database, like it came from like a CapIQ or like a FactSet or something.

So that's kind of a problem. It's a little black boxy in many cases.

We don't always know if you work for a large institution, it's, you're gonna have an inter internal group that gives you the you know, that calculation.

If you did it academically, I mean, if you, like you did it in school or something, then you know, who knows.

But, but you know, every firm kind of publishes their own internally.

They have research groups that are doing it.

Now, there are a few places outside of that where you can look, Deon the famous Deon, he publishes one.

and then the famous Felix also publishes one.

So we have over here we have, an equity risk premium on the, right now, there's a bunch of different ways to calculate the equity risk premium.

And they're in, in the actual, slide notes as well.

There's like arithmetic mean geometric mean.

I've never really had to do any of that, I think because I've always, I've always had it in, you know, internally.

I've always wor or I've been working with people who had it done internally.

So we have in here something called a survey, which kind of is our surveying the clients that we work with on where their rate is now. Unfortunately we haven't done a survey very recently.

So this is a little high.

Historically the equity risk premium has been, you know, probably between four and 6%, you know, for a very long time.

A long, long time ago it was, it was higher, but it's been in that five to six range for, it was six when I was in banking, then it came down to five, then it went back up.

Now it's kind of around five and a half.

So what I'm gonna do here is I'm just gonna put in custom and I'm gonna put in 5% and that's gonna be my fi I'll do five, I'll do five and a half, five and a half percent.

That's gonna be my equity risk premium.

So I'll put that back over here. 5.5%.

And the adjusted beta for this company is 1.31. So this isn't the raw beta, this is the unlevered beta rever.

I think, lemme just double check.

I always second guess myself. The adjusted beta.

Oh no, adjust the raw beta using the bloom method.

Okay, so actually this is the raw beta.

It's just that we've just done something kind of fancy to it to make it a raw kind of adjusted beta. So we can go, we can use that, which is good.

That's the good news. So I'm gonna take this 1.31, which is the raw beta and I'll put that in here.

And now it's saying what's the estimated cost of equity? Well, the estimated cost of equity according to to Felix is 12.1%.

I'm just curious if we can get to that somehow, if we can kind of get to that.

I, now what we can do here is we can go up into the data and go to discount rate.

And I'm doing us, because it's a US company and I want non-financial.

And we see up here at the top that it's, it's pulling in some industry data for us.

A lot of that stuff that was in the dropdowns is here.

There's that 6.9 what was it actually? 6.08, the survey. ERP.

Remember that I said that was the, what we asked the other banks about.

I said I thought that was still a little high.

and then it's got some stuff here on the spreads and stuff too, which we're gonna use for the cost of debt. But I wanna see if I can, if I can figure out, you know, from an, from an industrial perspective, what the, what the industry beta is, the industry beta that I should be using here.

And it looks like the industry unlevered five-year beta, which is what you'd want to use five-year beta.

Now you're saying, well, five-year beta, 10 year treasury, five-year beta is what, what we generally do use treasuries. You kind of have a little bit of room with.

And if I just go to, I don't know, what would it be? A building not building products. What, what would, what would this company be?

Materials is that in here? Metals and mining

Yeah, I'm gonna say what's Miscellaneous? What's miscellaneous? Yeah, it's a little high though.

I think basic industries would be lower. Yeah.

I'm gonna say construction hardware and materials. Yeah, that's what I, I kind of, I kind of think it, it is somewhere in there.

So that would be like 0.85.

Unlevered industry beta 0.85.

and now let me see, what was the unlevered beta 1.01? So 0.85.

So I'm just curious if we took the 0.8, you know, if we took this unlevered beta is 1.01, but the in, but the unlevered industry beta is 0.85, you know, which should we use? And I don't know enough about this company or this industry to make, kind of make a decision here, but I, I guess what I'm trying to introduce with this exercise is that there, there's a lot of, you know, there, there's a lot of kind of touchy feely stuff that goes into this.

You know, which number do I take, which is better? And obviously they could have a big impact on, on the numbers, right? All of these, if we took the, a different risk premium, if we took a different raw beta, if we took a different we took the industry unlevered versus the company unlevered, you know, that's all gonna have you know, a very big impact.

So I'm just curious, if I took the cost of equity at 12.1%, if I took, let's see if how I get to that.

If I take the equity risk the risk free plus the equity risk premium times 1.31, I get 12.1%.

So that's how they, that's how they, they got that 12.1% using the adjusted beta.

And it looks like that could be a little bit high.

If you had the opinion that the industry beta was where we should go, that the industry beta is, is a better unlevered place to start that that could pull this down.

I don't know what it would be. I don't, Because I don't have the capital structure information.

I'd have to find that.

Maybe I could even just go into the levered beta.

Why don't I just do that? What's the levered, what was the levered beta for this? Do, did you see that? Non-financial construction hardware materials, levered beta was levered five-year beta 1.07.

So if I change that to 1.07, that lowers my cost of equity to 10.8.

So I, I think that's a pretty big, pretty big deal.

And I don't have the answer for it.

I'm just kinda showing you the kind of the, the real world ambiguity of it.

lastly, we can just pull the cost of debt, from here.

But, um, we do have that information up here as well. If you wanted to see what the spreads are, right? This is, these are the basis point spreads for these various credit ratings, double A, single A, triple B, double B, et cetera, et cetera.

Hey, Chris, we have a question on the 10 year government, or sorry, the bond yield, the 4.9.

Can you show your Felix page where you pulled that from? Yeah, well I'm gonna show you here first.

Okay, so this is the risk-free rate, 10 year government, 10 year government bond is 4.9%. And that's what's showing, that's what should be showing here.

Now, does that seem high too? What is the 10 year, what's the 10 year treasury? I usually go to the Bloomberg. Oh, here it's, No, it's not, it says 4.63, so that, that could be right.

That's November 13th, right? Yeah, I don't, yeah, I'd have to go to, I usually go to the, to the, to the Fred St.

St. Louis federal Reserve.

The is where I usually go.

I didn't have it pulled up, but I think that's about right. Maybe touch high. I'm not sure.

Don't know what happened today, but that's where we got it from.

So if I go back to the actual page on Felix, it's um, it's right here.

The credit spread is 184 basis points.

So my cost of debt here is 6.74.

They are ratedB three.

So that's a sub investment grade company, right? And they're obviously very heavily levered. They've go about 2 billion, net of well, 1.7 billion net of cash over, about 5.7 billion of market cap.

Now for some reason, the WAC here isn't calculating, but I can just use this figure here, 3.3775 and get this done in the next minute and we'll be done.

Credit spread was, 1.84.

Cost of debt is that, plus this, who cares about the credit rating? total debt to capitalization we said was, 3775.

Um, no, that's debt to, um, debt to 2592.

Sorry, that's what we want for the WACC.

So I'm gonna do 25.9, which is the debt to capital times cost of debt.

I gotta do the after tax though, don't I? Let's make this after tax times one minus 0.21.

I don't think the tax rate's in here, so I'm just doing it.

I'm winging it. Sorry, I'm winging it here. Trying to get this done.

nothing like hard codes in your formulas, right? Right, folks, like, oh, who, who is this guy teaching us? And my whack is gonna be so the debt to capitalization times the 5.3 plus one minus debt to capitalization, that's the equity component times my cost of equity, and that gives me a wack of 10.3.

So I will clean this up and post this for everyone to, to see, but, I just want to kind of get through a messier real world problem.

And I appreciate you bearing with me on that.

Is there anything that, any other question that I can answer? I really liked the participation this week.

I think it helped quite a bit.

Thank you for your help with that as well, Yolanda.

If you have any questions, I'm happy to stick around and answer them. Otherwise you are certainly free to go. Hopefully I'll see some of you next week, holiday week.

I know it's a tough week to tackle free cash flows, but we will do it.

And I will, post all this.

It's Tuesday night and it's Tuesday as well.

It's not Wednesday, it's Tuesday.

and I will post, all this stuff for you and please chat me up if you have, if you have any any questions, as, as well in the meantime on this, maybe after the fact.

Feel free to do that. Sound good? I'm gonna go roast marshmallows down by the freeway and I will see you all, all next week.

We have a question. Where can I answer this? Lemme just answer it. Yeah, lemme just answer it before you start. That one came up before, did you? Yeah, Yeah, I thought I answered it.

So yeah, but, um, I don't know if that person is on, but you can get all the Excel sheets and the materials if you just go into Financial Edge into Moodle.

I'm assuming you have access to that.

There was the chat that was posted in the beginning.

Yeah, I didn't provide a link though. Okay, great. Looks like they got it.

Okay, cool. Great. Awesome.

Okay, Well thanks again everyone, and uh, we'll see you next week.

Goodnight. Have a good week.