Formula For Cost Of Capital

WACC Formula:

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

Equity (E):

currency

Total Value (V):

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Cost of Equity (Re):

Debt (D):

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Cost of Debt (Rd):

Tax Rate (Tc):

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 equity and debt. It is used as a hurdle rate for investment decisions and valuation purposes.

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, proportioned by their respective shares in the company's capital structure.

3. Importance of WACC Calculation

Details: WACC is crucial for capital budgeting decisions, company valuation (DCF analysis), investment appraisal, and determining the minimum acceptable return on new investments.

4. Using the Calculator

Tips: Enter all values in consistent currency units. Cost of equity and debt should be entered as percentages. Tax rate should be entered as a percentage (0-100). Ensure total value equals the sum of equity and debt.

5. Frequently Asked Questions (FAQ)

Q1: What is a good WACC value?
A: There's no universal "good" WACC - it varies by industry, company risk, and economic conditions. Generally, lower WACC indicates cheaper financing costs.

Q2: How is cost of equity calculated?
A: Cost of equity is typically calculated using CAPM: \( R_e = R_f + \beta \times (R_m - R_f) \), where \( R_f \) is risk-free rate, \( \beta \) is beta coefficient, and \( R_m \) is market return.

Q3: Why use market values instead of book values?
A: Market values reflect current investor expectations and opportunity costs, making them more relevant for investment decisions than historical book values.

Q4: What are the limitations of WACC?
A: WACC assumes constant capital structure, stable business risk, and may not be appropriate for projects with different risk profiles than the company overall.

Q5: How often should WACC be recalculated?
A: WACC should be reviewed quarterly or when significant changes occur in market conditions, capital structure, or business risk profile.