Cost Of Capital Formula Ca Inter

WACC Formula:

\[ WACC = \left(\frac{E}{V} \times K_e\right) + \left(\frac{D}{V} \times K_d \times (1 - T)\right) \]

Equity Proportion (E/V):

dimensionless

Cost of Equity (Ke):

Debt Proportion (D/V):

dimensionless

Cost of Debt (Kd):

Corporate Tax Rate (T):

Weighted Average Cost of Capital (WACC):

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1. What is WACC?

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 a crucial metric in corporate finance used for investment appraisal and valuation decisions.

2. How Does the Calculator Work?

The calculator uses the WACC formula:

\[ WACC = \left(\frac{E}{V} \times K_e\right) + \left(\frac{D}{V} \times K_d \times (1 - T)\right) \]

Where:

\( E/V \) — Equity proportion (dimensionless)
\( K_e \) — Cost of equity (%)
\( D/V \) — Debt proportion (dimensionless)
\( K_d \) — Cost of debt (%)
\( T \) — Corporate tax rate (%)

Explanation: The formula calculates the weighted average of the cost of equity and after-tax cost of debt, where weights are based on the proportion of equity and debt in the company's capital structure.

3. Importance of WACC Calculation

Details: WACC is used as the discount rate in capital budgeting decisions, company valuation through discounted cash flow analysis, and serves as a benchmark for investment returns. It helps determine whether an investment will create value for shareholders.

4. Using the Calculator

Tips: Enter equity and debt proportions as decimals (e.g., 0.6 for 60%), cost of equity and debt as percentages, and corporate tax rate as a decimal. Ensure that equity proportion + debt proportion = 1.

5. Frequently Asked Questions (FAQ)

Q1: Why is tax considered only on debt cost?
A: Interest on debt is tax-deductible, reducing the effective cost of debt, while dividends on equity are paid from after-tax profits.

Q2: What is a good WACC value?
A: A lower WACC is generally better as it indicates cheaper financing. The ideal WACC depends on industry, company risk, and market conditions.

Q3: How to calculate cost of equity?
A: Common methods include Capital Asset Pricing Model (CAPM), Dividend Discount Model, or Bond Yield Plus Risk Premium approach.

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

Q5: When should WACC be recalculated?
A: WACC should be recalculated when there are significant changes in capital structure, interest rates, tax rates, or company risk profile.