Weighted average cost of capital

A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - 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 component by its proportional weight and then summing:




Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

Investopedia Says:
Broadly speaking, a company’s assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances.

A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.

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Weights the percentage cost of each component by the percentage of that component in the financial structure.

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets.

The WACC is the minimum return that a company must earn on existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Companies raise money from a number of sources: common equity, preferred equity, straight debt, convertible debt, exchangeable debt, warrants, options, pension liabilities, executive stock options, governmental subsidies, and so on. Different securities are expected to generate different returns. The WACC is calculated taking into account the relative weights of each component of the capital structure and is used to see if the investment is worthwhile to undertake^[1].

The more complex the company's capital structure, the more laborious it is to calculate the WACC.

Contents 1 General formula 2 The formula for a simple case 3 References 4 See also 5 External links

General formula

In general, the WACC can be calculated with the formula^[2]:

, where N is the number sources of capital (securities, types of liabilities); r_i is the required rate of return for security i; MV_i is the market value of all outstanding securities i.

The formula for a simple case

In a simple case where the company is financed by homogeneous equity and debt, the weighted average cost of capital can be found through:

, where , where:

Symbol	Meaning	Units
	required or expected rate of return on equity, or cost of equity	%
	required or expected rate of return on borrowings before taxes	%
	risk free rate	%
	risk premium rate	%
	Beta coefficient	-
	corporate tax rate	%
	total debt and leases (including current portion of long-term debt and notes payable)	currency
	total market value of equity and equity equivalents or market cap (number of shares outstanding X share price)	currency
	total capital invested in the going concern	currency

References

1. ^ G. Bennet Stewart III (1991). The Quest for Value. HarperCollins. 
2. ^ J. Miles und J. Ezzell. "The weighted average cost of capital, perfect capital markets and project life: a clarification." Journal of Financial and Quantitative Analysis, 15 (1980), S. 719-730.

See also

• Beta coefficient
• Cost of capital
• Discounted cash flow
• Economic Value Added
• Internal rate of return
• Minimum acceptable rate of return
• Modigliani-Miller theorem
• Net present value
• Opportunity cost

External links

• Video about practical application of the WACC approach
• Yee, Kenton K., "Earnings Quality and the Equity Risk Premium: A Benchmark Model" . Contemporary Accounting Research, Vol. 23, No. 3, pp. 833-877, Fall 2006. Available at SSRN: http://ssrn.com/abstract=921914.
• Velez-Pareja, Ignacio and Tham, Joseph, "A Note on the Weighted Average Cost of Capital WACC" (August 7, 2005). Available at SSRN: http://ssrn.com/abstract=254587. Unpublished.
• WACC calculator Microsoft Excel spreadsheet
• A more realistic valuation: APV and WACC with constant book leverage ratio
• calculate the firm's Weighted Average Cost of Capital to publicly traded stock (only with the ticker symbol)
• calculate the WACC with your own values to understand the equation
• Find the WACC of any publicly traded company by entering the firm's stock ticker symbol
• Paper describing a method for generating the WACC curve when there is default risk - spreadsheet available

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