Weighted Average Cost of Capital Assignment
WACC for a Real Firm
Weighted average cost of capital (Links to an external site.) (WACC) is used by analysts and investors to assess an investor’s returns on an investment in a company. As most businesses run on borrowed funds, the cost of capital becomes an important parameter in assessing a firm’s potential for net profitability. WACC measures a company’s cost to borrow money, where the WACC formula uses both the company’s debt and equity in its calculation.
- The weighted average cost of capital (WACC) is a calculation of a firm’s cost of capital in which each category of capital is proportionately weighted.
- All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC calculation.
- WACC is calculated by multiplying the cost of each capital source (debt and equity) by its relevant weight by market value, and then adding the products together to determine the total.
- The cost of equity can be found using the capital asset pricing model (CAPM).
- WACC is used by investors to determine whether an investment is worthwhile, while company management tends to use WACC when determining whether a project is worth pursuing.
The Formula for WACC
The WACC formula includes the weighted average cost of equity plus the weighted average cost of debt. Note that, generally, the cost of debt (Links to an external site.) is lower than the cost of equity given that interest expenses are tax-deductible.
WACC= (EV × Re) + (DV × Rd × (1− Tc)) where: E = Market value of the firm’s equity D = Market value of the firm’s debtcV =E + DRe = Cost of equity Rd = Cost of debt Tc = Corporate tax rate WACC = (VE × Re) + (VD × Rd × (1− Tc)) where: E = Market value of the firm’s equity D = Market value of the firm’s debt V = E + DRe = Cost of equity Rd = Cost of debt Tc = Corporate tax rate
How to Calculate WACC
WACC formula is the summation of two terms:
(EV × Re)(VE × Re) (DV × Rd × (1− Tc)) (VD × Rd × (1−Tc))
The former represents the weighted value of equity-linked capital, while the latter represents the weighted value of debt-linked capital.
For Weighted Average Cost of Capital Help please click here