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multiplied the cost of debt capital by a fraction derived from
the ratio of debt to equity (instead of the ratio of debt to
total capital); and he added the two products together to produce
his WACC amounts.
Sledge, in his rebuttal report, points out (correctly) that
Hakala’s debt multiplier should have been the ratio of debt to
total capital; that the sum of the debt multiplier and the equity
multiplier should be 1.000, while Hakala’s sum was 1.0123; and
that this error by Hakala resulted in Hakala’s overstating the
WACC and thereby understating the amount of reasonable
compensation. (Sledge also has errors, discussed infra.)
Hakala has chosen to use 11.70 percent as the basic debt-
equity ratio. From this, he derives the equity multiplier of
0.8953 (this is one, divided by 1.117). It follows that the debt
multiplier should be 1.0 minus 0.8953, or 0.1047, and not the
0.117 that Hakala used. If we correct this error and the above-
noted error of 15.06 percent rather than 15.03 percent for the
cost of equity capital, then Hakala’s CAPM approach should yield
a 1995 WACC of 14.08, instead of Hakala’s 14.16. Similar
corrections would apply to the 1996 WACC. Because a lower WACC
leads to higher reasonable compensation under Hakala’s approach,
these corrections in Hakala’s numbers would result in an increase
in the reasonable compensation numbers that Hakala recommends.
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