Cost of Capital

Component Cost

Component cost is the description of the costs used to calculate WACC, and was calculated using cost of debt and cost of common equity. The cost of debt is the interest rate that a company pays on debts, including bonds and loans. As recorded by Factset, Denny's had a pre-tax cost of debt of 2.91%, a tax rate of 23%, concurring a total after-tax cost of debt of 2.24%. Competitors in the industry like Darden Restaurants saw an after-tax cost of debt of around 5%, while competitor Bloomin Brands saw about 4%. Having a lower cost of debts indicates that Denny's has slightly less risk that competitors, and displays better potential income growth.

Cost of Debt

Cost of Common Equity

The cost of common equity was calculated using CAPM, or the Capital Asset Pricing Model. This model calculated the cost of equity based on Denny's risk-free rate, Beta, and MRP. The risk-free rate was based on the 10-year government yield. Beta represents the riskiness and volatility of the company; a Beta of 1 means the company is on line with the market movements, and a higher beta indicates higher volatility of the company in comparison with market movements. Denny's Beta of 1.7 indicates that it is volatile, so when the market does well Denny's will do even better, but if the market suffers losses Denny's will be hit even worse; this is common in the restaurant industry. The MRP, or market risk premium, is the difference between the risk-free rate and the expected return on an average market portfolio. The cost of equity was calculated by multiplying Beta by the MRP, then adding the risk-free rate to determine an overall cost of 11.03%. Competitors in the industry indicated similar or slightly higher costs of equity, so Denny's lower costs demonstrate a relatively stable, healthy and low risk environment.

Sensitivity of WACC

As seen in the image below, a sensitivity analysis was calculated for the components of WACC using values from ValueLine, Factset, and S&P Capital IQ. Each of these sites has slightly different variations of Beta and CAPM, and thus slight variations of the WACC calculation as well. Ultimately, the Beta used in my calculations was from Factset, the 1.7 value; however, this is higher than Valueline and Capital IQ use, which respectively were 1.6 and 1.54. If one of those values had been used in calculations, the resulting WACC would marginally decrease. It is important to note these variations in estimated values because investors want to have a rounded perspective, backed by multiple sources, so when the rough average of those variations is the same as the estimate it is obvious that it is more or less correct.