Cost Of Capital Formula With Example

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):

USD

Total Value (V):

USD

Cost of Equity (Re):

Debt Value (D):

USD

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 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 financing (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 using discounted cash flow analysis, and evaluating investment opportunities. It represents the minimum return a company must earn on its existing asset base to satisfy its investors.

4. Using the Calculator

Tips: Enter all values in USD for equity, total value, and debt. Cost of equity, cost of debt, and tax rate should be entered as percentages. Ensure that E + D equals V 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 for the company.

Q2: What are typical WACC ranges?
A: WACC typically ranges from 5% to 15%, varying by industry, company risk, and market conditions.

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

Q4: When should WACC be used?
A: WACC is used as discount rate in DCF valuation, capital budgeting for projects with similar risk to the company, and performance evaluation.

Q5: What are 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.