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to be used in applying the DCF method to Korbel’s cashflows is
Korbel’s “weighted average cost of capital” (WACC).9 Dr. Bajaj
computed the WACC as 14.22 percent; Dr. Spiro computed it as
16.54 percent. Their only significant disagreement is as to one
component of the WACC, the cost of equity capital.10 Dr. Bajaj
computed the cost of equity capital as 14.70 percent; Dr. Spiro
computed it as 16.71 percent.
We need not engage in an extended discussion of the
appropriate cost of equity capital since, in computing the WACC,
other things being equal, the higher the cost of equity capital
(i.e., the larger the percentage), the larger the WACC. Given
the DCF method, the larger the WACC, the lower the present value
of expected cashflows. The parties endorse the DCF method,
differing only as the value of certain variables. Since we are
8(...continued)
investors demand for accepting delayed payment.”).
9 As expressed by Dr. Spiro:
WACC = Wd x Kd x (1-t) + We x Ke
Where:
WACC = weighted average cost of capital,
Wd = weight of debt in capital structure,
Kd = estimated pretax cost of debt,
t = income taxes at 1.5 percent,
We = weight of equity in capital structure, and
Ke = cost of equity capital.
10 Dr. Spiro defined the cost of equity capital as follows:
“[T]he rate of return required by an investor as sufficient
compensation for committing equity funding to the business.”
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