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 = * Re + * Rd * (1 – Tc)

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

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 =[( * 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 stock 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. Why do I need to unlever beta when making WACC calculations?

    Dive into weighted average cost of capital calculations, and see why firms both unlever and re-lever beta to compare debt ... Read Answer >>
  6. 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 >>
Related Articles
  1. Bonds & Fixed Income

    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. Investing

    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. Economics

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
  4. Professionals

    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.
  5. Personal Finance

    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. Forex Education

    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 News

    Apple's $12 Billion Bond Issue Meant to Boost WACC

    Apple, Inc. announced that it would issue $12 billion in corporate bonds to the public in order to return profits to shareholders via dividends and a share buyback program of equivalent size.
  8. Fundamental Analysis

    Equity Multiplier

    The equity multiplier is a straightforward ratio used to measure a company’s financial leverage. The ratio is calculated by dividing total assets by total equity.
  9. Bonds & Fixed Income

    Evaluating A Company's Capital Structure

    Learn to use the composition of debt and equity to evaluate balance sheet strength.
  10. Investing Basics

    Breaking Down Optimal Capital Structure

    An optimal capital structure shows the best balance of debt to equity a company can have in order to minimize its cost of capital.
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. Composite Cost Of Capital

    A company's cost to borrow money given the proportional amounts ...
  6. Traditional Theory Of Capital Structure

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

    Physical capital is one of the three main factors of production in economic theory. It consists of manmade goods that assist ...
  2. Reverse Mortgage

    A type of mortgage in which a homeowner can borrow money against the value of his or her home. No repayment of the mortgage ...
  3. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  4. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  5. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  6. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
Trading Center