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Cost of Capital
Cost of Capital
Many growth oriented companies undertake capital projects in order to increase revenues and grow the company through long term strategy. For HST, capital projects can include major hotel renovations. These capital projects are costly and must be justified by exceptional returns on investment. One way to measure this is by calculating the cost of capital. This metric provides the return that a company should achieve in order to justify the capital project being worth the expenditures.
*Figure 4.3: HST Capital Structure. Source: Excel
I was able to calculate Hosts cost of capital as WACC or "weighted average cost of capital" as depicted in figure 4.3 above. WACC is the cost of capital, however, weighted proportionally to the company's long-term debt (30.15%) and common equity (69.85%). I was able to determine the weights of these two components by first identifying the company's long term debt (including leases and the current portion) from the balance sheet. I then calculated the market value of equity using the company's current stock price (as of December 5th, 2022) and multiplying this value by the number of outstanding shares which I pulled from Value Line. Having the long term debt and market value of equity, I was able to determine their weight out of their total, which I then multiplied by their costs. After adding up their weighted costs, I came up with a WACC of 8.55%. Since WACC represents the expense of raising one additional dollar of capital, it would cost Host around $0.08 per additional dollar. According to a report by the Stern School of Business at New York University, the average WACC for the REIT industry is 5.51%. Although it is not concerning, Hosts WACC is slightly above industry average, which is something investors should take into account.
** Full calculations for Capital Structure model can be found in the attached Excel file here
Component Cost
Component Cost
Cost of Debt
Cost of Debt
*Figure 4.4: HST Cost of Debt. Source: Excel
I was able to calculate the cost of debt for Host which is the effective rate they pay on their debts such as loans. I was able to do this by pulling the pre-tax cost of debt from FactSet as seen in figure 4.5 to the right. The next step was to multiply the pre-tax cost of debt by one minus the tax rate. I sourced the tax rate (12%) from a previously calculated vertical analysis of the company's income statement. The tax rate came from an average of fiscal years 2017 and 2018 since the later years were outliers from the COVID-19 pandemic. This gave me the after-tax cost of debt which was approximately 5.24%
** Full calculations for Cost of Debt model can be found in the attached Excel file here
*Figure 4.5: HST pre-tax Cost of Debt. Source: FactSet
Cost of Common Equity
Cost of Common Equity
*Figure 4.6: HST Cost of Common Equity. Source: Excel
I was able to examine the second component cost of capital, equity, by using the CAPM model (capital asset pricing model). This model shows the relationship between risk and the expected return of an asset. Its components include the risk free rate which I sourced from 10 year government yields since they are considered a "riskless investment vehicle." I then sought out the firms beta from multiple sources including Valueline, Fact Set, and S & P Capital IQ. I ended up using a beta of 1.16 which I pulled from Fact Set since it was the median of the three. The last component of the CAPM model is the market risk premium which was given from Fernandez et al. 2021 at 5.50%. I added the risk free rate and the beta then multiplied that value by the MRP to get a cost of equity at 9.98%. This is the expected rate of return an investor can expect to recieve when investing in the company.
** Full calculations for Cost of Common Equity model can be found in the attached Excel file here
Sensitivity Analysis
Sensitivity Analysis
*Figure 4.7: HST Sensitivity Analysis. Source: ValueLine, Factset, S&P Capital IQ.
After calculating the WACC, cost of debt, and cost of equity, I then conducted a WACC sensitivity analysis to wrap up my findings. In my analysis, WACC was dependent on beta as pictured in figure 4.7 above. I tested multiple betas that were sourced from Value Line, Fact Set, and S&P Capital IQ. The range of the three betas was only 0.15. If WACC was calculated with the lowest beta of 1.1 from Value Line, WACC would decrease to 6.87%. Using the Fact Set beta of 1.6, WACC sat at 7.10% and with S&P Capital IQs beta of 1.25, WACC rose to 7.45%. As you can see, WACC is highly dependent on beta.
** Full calculations for Sensitivity Analysis can be found in the attached Excel file here
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