WACC

Knowledge Center

   

Analyzing the cost of invested capital. Explanation of WACC. Weighted Average Cost of Capital.

Contents

  1. Summary
  2. Forum
  3. Best Practices
  4. Expert Tips
  5. Resources

Print

What is the WACC? Definition

Corporations create value for shareholders by earning a return on the invested capital that is above the cost of that capital. WACC (Weighted Average Cost of Capital) is an expression of this cost. It is used to see if value is added when certain intended investments or strategies or projects or purchases are undertaken.


WACC is expressed as a percentage, like interest. For example, if a company works with a WACC of 12%, than this means that only investments should be made and all investments should be made, that give a return higher than the WACC of 12%. 


The costs of capital for any investment, whether for an entire company or for a project, is the rate of return which capital providers would want to receive if they would invest their capital elsewhere. In other words, costs of capital are a type of opportunity cost.


Calculation of WACC. Formula

The easy part of WACC is its debt part. In most cases it is clear how much a company has to pay their bankers or bond holders for debt finance. More difficult however, is the cost of equity finance. Normally, the cost of equity capital is higher than the cost debt finance, because equity involve a risk premium. See also: Cost of Capital.


Factors that make calculating WACC difficult:

  1. Calculating this risk premium is one thing that makes the calculation of WACC complicated.
  2. Another important complication is which mix of debt and equity should be used to maximize shareholder value. This is what "Weighted" means in WACC.
  3. Finally: also the corporate tax rate is important, because normally interest payments are tax deductible.

The WACC formula:


       Debt / TF (cost of debt)(1-Tax)

+     Equity / TF (cost of equity)

-------------------------------------------------

       WACC


In this formula,

  • TF means Total Financing. Total Financing consists of the sum of the market values of debt and equity finance. An important issue with TF is whether, and under what circumstances, it should include current liabilities, such as trade credit. In valuing a company this is relevant, because:
    • Trade credit is used aggressively by many companies.
    • There is an interest (or financing) charge for such use.
    • Trade credit can be a large amount on the balance sheet.
  • Tax stands for the corporate tax rate.

Example of WACC calculation.

Suppose the following situation in a company:


The market value of debt = 300 million
The market value of equity = 400 million
The cost of debt = 8%
The corporate tax rate = 35%
The cost of equity is 18%
 

The WACC of this company is:


     300 : 700 * 8% * (1-35%)

+   400 : 700 * 18%

------------------------------------------------


     12,5% (WACC - Weighted Average Cost of Capital)



WACC Forum
  Weighted Marginal Cost of Capital
Dear Friends, kindly, I need your support to get more knowledge about Weighted Marginal Cost of Capital. What is meant with that and what is the difference with WACC?...
     
 
  Importance of WACC for Unquoted Organisation?
What are the importances of WACC to an unquoted organisation? Thanks...
     
 
  Why WACC? Importance
Why do firms calculate WACC?
Is it good to use individual component costs in calculating the firms' cost of capital?...
     
 
  Calculation of Relevant Risk Premium is Tricky
It's a tricky issue to calculate the most relevant risk premium required for the calculation of the WACC for a company, as there seem to be many relevant market portfolios prevailing in the country of operation and across the globe in the present era...
     
 

WACC Special Interest Group


Special Interest Group

WACC Education & Events


Find Trainings, Seminars and Events


Best Practices - WACC Premium
  Calculating WACC | WACC Calculation
I have been asked to calculate the WACC using the following info: Capital structure: Ordinary shares (fully paid) :1000000, preference shares: (11%) 400000, debentures: (10%) 600000. The ordinary share holders expect a divident of 14% per year. Corpo...
     
 

Expert Tips - WACC Premium

Resources - WACC Premium

WACC User Guide

The estimation of corporate capital costs is complicated by many practical issues that create numerous degrees of freedom and lead to wide-ranging res...
Usage (application): Estimation of capital costs
 

Introduction and Calculation of WACC and its Components

Establishes an initial understanding of:
- Cost of Capital
- Cost of Equity
- Cost of Debt
- WACC
Includes calculation with c...
Usage (application): Initial Understanding and Calculation of WACC and Cost of Capital, Trainings, Workshops
 

Top-9 CF Valuation Mistakes

In cash flow valuation (CFV), there are two main categories of mistakes: derivation of the appropriate cash flows and estimation of the cost of capita...
Usage (application): Cost of capital, WACC, valuati
 

Top 9 Unnecessary and Avoidable Mistakes in Cash Flow Valuation

Estimate the current cost of capital for your firm. Spreadsheet by Aswath Damodaran....
Usage (application): Current Cost of Capital, WACC, Valuation
 

Corporate Valuation for Businesses

Presentation that elaborates on corporate valuation, including the following sections:
1. Three types of value:
- Book Value
- Market V...
Usage (application): Corporate Valuation, Book Value, Market Value, Intrinsic Value, Fundamental Value, M&A, VBM, Fundamental Investing
 
 

News

Wacc Calculation
     
 

News

Wacc Capital
     
 

Videos

Wacc Calculation
     
 

Videos

Wacc Capital
     
 

Presentations

Wacc Calculation
     
 

Presentations

Wacc Capital
     
 

More

Wacc Calculation
     
 

More

Wacc Capital
     

Compare with WACC: Cost of Capital  |  Internal Rate of Return  |  Net Present ValueDiscounted Cash Flow  |  Cost of Equity


Return to Management Hub: Decision-making & Valuation  |  Finance & Investing


More Management Methods, Models and Theory

Special Interest Group Leader

You here


About 12manage | Advertising | Link to us | Privacy | Terms of Service
Copyright 2016 12manage - The Executive Fast Track. V14.0 - Last updated: 1-6-2016. All names tm by their owners.