How Is Cost Of Capital Calculated

WACC Formula:

\[ WACC = \left(\frac{E}{V} \times R_e\right) + \left(\frac{D}{V} \times R_d \times (1 - T_c)\right) \]

E/V (Weight of Equity):

(0-1)

Re (Cost of Equity):

D/V (Weight of Debt):

(0-1)

Rd (Cost of Debt):

Tc (Tax Rate):

(0-1)

Weighted Average Cost of Capital (WACC):

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1. What Is Weighted Average Cost Of Capital?

The Weighted Average Cost of Capital (WACC) represents a company's average after-tax cost of capital from all sources, including common stock, preferred stock, bonds, and other forms of debt. It's used as a hurdle rate for investment decisions and company valuation.

2. How Does The Calculator Work?

The calculator uses the WACC formula:

\[ WACC = \left(\frac{E}{V} \times R_e\right) + \left(\frac{D}{V} \times R_d \times (1 - T_c)\right) \]

Where:

\( E \) — Market value of equity
\( V \) — Total market value of equity and debt (\( E + D \))
\( R_e \) — Cost of equity
\( D \) — Market value of debt
\( R_d \) — Cost of debt
\( T_c \) — Corporate tax rate

Explanation: The formula calculates the weighted average of the cost of equity and the after-tax cost of debt, where weights represent the proportion of each financing source in the company's capital structure.

3. Importance Of WACC Calculation

Details: WACC is crucial for capital budgeting decisions, company valuation using discounted cash flow analysis, and assessing investment opportunities. A lower WACC indicates cheaper financing costs and potentially higher company value.

4. Using The Calculator

Tips: Enter weights as decimals (e.g., 0.6 for 60%), cost percentages as whole numbers (e.g., 8 for 8%), and tax rate as decimal (e.g., 0.25 for 25%). Ensure E/V + D/V = 1 for accurate results.

5. Frequently Asked Questions (FAQ)

Q1: Why is debt cost adjusted for taxes?
A: Interest payments on debt are tax-deductible, reducing the effective cost of debt, hence the (1 - Tc) multiplier.

Q2: What is a good WACC percentage?
A: There's no universal "good" WACC - it varies by industry, company risk, and economic conditions. Generally, 8-12% is common for many established companies.

Q3: How is cost of equity calculated?
A: Typically using Capital Asset Pricing Model (CAPM): Re = Rf + β(Rm - Rf), where Rf is risk-free rate, β is beta, and Rm is market return.

Q4: What if my E/V + D/V doesn't equal 1?
A: The calculator will still compute, but results may not reflect actual capital structure. For accuracy, ensure weights sum to 1.

Q5: Can WACC be negative?
A: In theory yes, but extremely rare in practice. Could occur with negative interest rates and unusual capital structures, but typically WACC is positive.