Loading the player...
A:

Weighted average cost of capital (WACC) is the average after-tax cost of a company’s various capital sources, including common stock, preferred stock, bonds, and any other long-term debt. A company has two primary sources of financing - debt and equity - and, in simple terms, WACC is the average cost of raising that money. WACC is calculated by multiplying the cost of each capital source (debt and equity) by its relevant weight, and then adding the products together to determine the WACC value:

WACC = x Re + x Rd x (1 – Tc)

Where:

When calculating a firm's WACC, the first step is to determine what proportion of a firm is financed by equity and what proportion is financed by debt by entering the appropriate values into the and components of the equation. Next, the proportion of equity () is multiplied by the cost of equity (Re); and the proportion of debt () is multiplied by the cost of debt (Rd).

The debt side of the equation (* Rd) is then multiplied by (1 - Tc) to get the after-tax cost of debt (there is a tax shield associated with interest). The final step is to add the equity side of the equation to the debt side of the equation to determine WACC.

For example, a firm's financial data shows the following:

  • Equity = $8,000
  • Debt = $2,000
  • Re = 12.5%
  • Rd = 6%
  • Tax rate = 30%

To find WACC, enter the values into the equation and solve:

WACC =[( x 0.125)] + [( * 0.06 * (1 - 0.3)]

WACC = 0.1 + .0084 = 0.1084 or 10.84%; the WACC for this firm then is 10.84%.

Because the calculation takes time, most investors use online analysis tools to find a company's WACC.

RELATED FAQS
  1. What does a high weighted average cost of capital (WACC) signify?

    Find out what it means for a company to have a relatively high weighted average cost of capital, or WACC, and why this is ... Read Answer >>
  2. What is the formula for calculating weighted average cost of capital (WACC) in Excel?

    Learn about the weighted average cost of capital (WACC) formula and how it is used to estimate the average cost of raising ... Read Answer >>
  3. How do interest rates affect the weighted average cost of capital (WACC) calculation?

    The interest rate is one of many external factors that can change the inputs in the weighted average cost of capital (WACC) ... Read Answer >>
  4. How do you calculate the ratio between debt and equity in the cost of capital

    Discover how to calculate the ratio between debt and equity when making cost of capital estimations using the weighted average ... Read Answer >>
  5. Do companies measure their cost of debt with before- or after-tax returns?

    Understand the before and after-tax calculations of cost of debt capital and how each is useful in deciding between funding ... Read Answer >>
  6. What are the benefits and shortfalls of the Herfindahl-Hirschman Index?

    Learn about the differences between equity and debt financing and how they impact financials. Find out how businesses determine ... Read Answer >>
Related Articles
  1. Investing

    Investors Need A Good WACC

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality.
  2. Managing Wealth

    Weighted Average Cost Of Capital (WACC)

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality
  3. Personal Finance

    Top Things To Know For An Investment Banking Interview

    Without some basic knowledge, you won't get the job. Find out what you need to know and how to prepare.
  4. Small Business

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
  5. Investing

    Target Corp: WACC Analysis (TGT)

    Learn about the importance of capital structure when making investment decisions, and how Target's capital structure compares against the rest of the industry.
  6. Investing

    How to Calculate Required Rate of Return

    The required rate of return is used by investors and corporations to evaluate investments. Find out how to calculate it.
  7. Investing

    DCF Valuation: The Stock Market Sanity Check

    Calculate whether the market is paying too much for a particular stock.
RELATED TERMS
  1. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a ...
  2. Cost Of Capital

    The required return necessary to make a capital budgeting project, ...
  3. Return On New Invested Capital - RONIC

    A calculation used, either by a firm or investors, to determine ...
  4. Economic Spread

    1. A performance metric that is equal to the difference between ...
  5. Cost of Debt

    The effective rate that a company pays on its current debt. This ...
  6. Traditional Theory Of Capital Structure

    The theory that when the Weighted Average Cost of Capital (WACC) ...
Hot Definitions
  1. Debt Security

    Any debt instrument that can be bought or sold between two parties and has basic terms defined, such as notional amount (amount ...
  2. Taxable Income

    Taxable income is described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly AIMR) that measures the competence and integrity of financial ...
  4. Initial Coin Offering (ICO)

    An Initial Coin Offering (ICO) is an unregulated means by which funds are raised for a new cryptocurrency venture.
  5. The Bernie Madoff Story

    Bernie Madoff ran a multibillion-dollar Ponzi scheme that is considered the largest financial fraud of all time.
  6. Pyramid Scheme

    An illegal investment scam based on a hierarchical setup. New recruits make up the base of the pyramid and provide the funding, ...
Trading Center