Finding a Company's WACC and the Optimal Capital Structure
Prof. Ian Giddy, New
You have the opportunity to visit SAP AG, the business software company.
Based in Walldorf, Germany, SAP offers software development and implementation
in application areas such as accounting, logistics and human-resource management
to large businesses in Europe, North America and around the world. In 2000
the company had sales of over EUR6.2 billion.
In recent months the company's stock price has been depressed, and management
is concerned about re-examining the financial structure. Management is also
concerned with the financing of forthcoming acquisitions: should SAP continue
to take advantage of its strong cash flow, or should it begin to use debt
financing? If it does raise additional debt, the proceeds will be used for
a stock buyback.
You have been asked to evaluate whether the company has an appropriate
amount of debt. In 2001 the following information about SAP's
current position was collected:
Current share price: 117 EUR
Shares outstanding: 316 million
Beta of the stock based on the German DAX index: 1.3
Debt outstanding: 200 EUR million
Debt rating: AAA
Market rate on bonds with rating AAA 5.65%
Government 10-year bond rate: 4.80%
DAX long-run expected return 9.80% or 5.00% over governments
Company's marginal tax rate: 38%
2001 estimated pretax profit: 1568
2001 est. book value of equity: 3734
Based on the company's business, its interest coverage and other factors, the following table shows what an increase in long term debt would do to the company's ratings
and its cost of borrowing as well as several key ratios:
||Interest coverage ratio
1. Should SAP take on additional debt? If so, how much?
2. What is the weighted average cost of capital before and after the additional
3. How much does SAP's value increase as a result of the lower cost of capital?
What will be the estimated price per share after the company takes on new
1. To answer these questions, you will have to obtain updated data about the company, its share price, etc.
2. To assess the impact on SAP's value, you may assume that the additional value comes from the savings
from a lower cost of capital each year, and that the savings will continue
Exhibit 1: Summary
SAP Financials (please obtain updated data)
Exhibit 2: Corporate Bond
Spreads (please obtain updated data)
Exhibit 3: Cost of Capital Calculation
solution: sapcase.xls (if you use this, please use updated data)