A Hypothetical Business using WACC

I’m going to take a different approach here to answer the questions. Here is a hypothetical business: Acme Electric Inc. I have used the WACC approach to prove that the project is viable.

Here is a brief description of the business.

  • 20 years in the Electrical maintenance, installation and design of electrical systems
  • Very small debt ratio
  • Gross sales 2.5 million /year
  • Privately owned corporation
  • 50 + employees

Project: Installation and ownership of a 75 megawatt wind farm in the Pocono Mountains, Pa. Owner and operator of the wind farm will be Acme Electric. Land is owned by Acme Electric Inc. Total cost of the project will be 450 million with the following.

Using the XL spreadsheet I came up with the following: Cost of Equity (CAPM)

  • Equity Risk Free Rate – 3%
  • Nova Beta – 1.5
  • Expected Market Risk Premium – 6%
  • Cost of Equity – 12%
  • Market Rate of Return – 9%
  • WACC – 11.1%

The WACC is good enough to get investors to look into the project. Acme Electric will need to get investors to finance 350 million of the project.

They have a few options here.

  1. Apply for government financing or grants
  2. Have a financial company issue 20 year non-rated bonds
  3. Sell stock in the company
  4. Go public and have and ISO
  5. Apply for a conventional loan

They may need to do a combination of some of them.

Acme will also need to supply a financial statement done by a CPA to any institutions looking to invest. This is a doable project with a profitable return and according to a Bloomsburg’s article, “Equity buyers qualified for a tax benefit and one of the debt components offered a yield of about 7 percent, he said. “We raised the money in about six weeks,” he said. “There are a lot of opportunities for smaller-scale wind farm operations.” [1]

Understanding the weighted average cost of capital (WACC) is key to determining if investors will consider financing the project. The investors want to know what the rate the company is expected to pay. Anyone that invests wants to know two things, what is my rate of return and what are my risks? Doing a WACC gives an estimated return on the project. Supplying a certified financial history of the company along with knowing the Beta supplies a good understanding of the risks

[1] http://www.bloomberg.com/news/2012-05-15/small-u-s-wind-farms-to-grow-as-tax-incentives-expand.html

One thought on “A Hypothetical Business using WACC

  1. Wow, this is a very sophisticated approach to establishing the viability of your project. I like that you accounted for the financial soundness of the parent company as well as the project itself. This is an important factor to investors that many entrepreneurs struggle with when their businesses are just starting out. Do you perform financial analyses like this as part of your job?

    Link to my blog: http://engr312.dutton.psu.edu/2014/10/20/lesson-8-considerations-for-financing-renewable-energy/

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