Modeling Raytheon’s Cost of Capital: Insights into WACC's Sensitivity given Market Behavior

patricktscott11
Jan 5
2 min read

Updated: Jan 6

(Abnormal MRP): Understanding Raytheon's Cost of Capital and WACC

Investors modeling Raytheon's current Weighted Average Cost of Capital (WACC), may find understated WACC values due to an understated Cost of Equity. This is specifically due to an atypical Market Risk Premium (MRP) from the period ranging Jan 2022- Jan 2025.¹ A value hovering at -3.26%, which therefore initially skews the calculation of Raytheon's Cost of Equity (Rₑ) under the Capital Asset Pricing Model. Whereas after running a regression analysis between the variables of: Raytheon's return subtracted from the risk free rate and the varying MRP, a skewed low Beta was conceived at .40. Furthermore when averaging the MRP from Jan 2022- Jan 2025, such volatility across financial markets and high interest rates during this period resulted in a abnormal historical MRP of -3.26%. Therefore, when coupling a negative MRP into the CAPM in order to calculate Rₑ, a relatively low Rₑ of 2.72% is outputted, furthermore skewing WACC calculations lower than anticipated to around 3%, (2.97%). A cost of capital at 3%, misleads investors in the form of a lower required rate of return for their capital, and thus does not accurately reflect Raytheon's risks of tied to operational effectiveness. A 3% WACC does not align with the cost of capital for the overall defense industry, whose varying revenue's correlate heavily to political, economic, and regulatory shifts. The average WACC across 70 Aerospace and Defense companies hovers at 8.83%.³

Raytheon's WACC begins to align with industry standards after inputting a normalized Beta and MRP. Such as, a longer input range when calculating Beta, with the 5 Year Monthly Beta rising to .54, from the 3 Year Monthly Beta of .40. Furthermore a normalized estimate of market risk premium, between 4-5%, was used in WACC calculations, resulting in a adjusted WACC of 5.67% of which more closely aligns with industry standards.

The lack of a normalized MRP in Raytheon's WACC calculation would have drastically inflated Raytheon's value in a further DCF analysis. Whereas a lower WACC reduces the denominator for each years respective cash flows, inflating their present value.

¹ The period ranging from Jan 2022- Jan 2025 reflected an abnormally low MRP hovering at around -3%. This can be attributed to atypical volatile market conditions generated from post pandemic recovery, coupled with rising interest rates to combat inflation. By analyzing monthly data, the model reflects the dynamic risk and return environment relevant to Raytheon's operations. This approach balances historical perspective with market relevance.

² Raytheon Close Prices= StockHistory Function

S&P 500 Close Prices = StockHistory function (SPY ETF)

R(f) Rate = 1- Month Treasury Yeild https://fred.stlouisfed.org/searchresults/?st=interest%20rate&isTst=1

³ https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/wacc.htm

(Abnormal MRP): Calculation of Historical MRP and Historical Beta using Regression Analysis: