Formula Of 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 Value (E):

currency

Total Value (V):

currency

Cost of Equity (Re):

Debt Value (D):

currency

Cost of Debt (Rd):

Corporate Tax Rate (Tc):

Weighted Average Cost of Capital (WACC):

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1. What is the 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 analysis.

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, with weights based on their proportion 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 investment projects.

4. Using the Calculator

Tips: Enter all values in consistent currency units. Cost of equity and debt should be entered as percentages. Corporate tax rate should be between 0-100%. Total value (V) must be greater than zero.

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 is debt cost adjusted for taxes?
A: Interest expenses are tax-deductible, reducing the actual cost of debt to the company, hence the \( (1 - T_c) \) adjustment.

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

Q5: When should WACC not be used?
A: For projects with significantly different risk characteristics, during major capital structure changes, or for companies with unstable financial conditions.