Cost Of Capital Formula

WACC Formula:

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

Equity to Value Ratio (E/V):

decimal

Cost of Equity (Re):

Debt to Value Ratio (D/V):

decimal

Cost of Debt (Rd):

Tax Rate (T):

decimal

Weighted Average Cost of Capital (WACC):

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1. What is the Cost Of Capital Formula?

The Cost of Capital Formula, specifically the Weighted Average Cost of Capital (WACC), represents the average rate of return a company is expected to pay its security holders to finance its assets. It is a crucial metric in corporate finance for investment decisions and valuation.

2. How Does the Calculator Work?

The calculator uses the WACC formula:

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

Where:

\( E/V \) — Equity to total value ratio
\( R_e \) — Cost of equity (%)
\( D/V \) — Debt to total value ratio
\( R_d \) — Cost of debt (%)
\( T \) — Corporate tax rate

Explanation: The formula calculates the weighted average of the costs of equity and debt, with debt cost adjusted for tax benefits.

3. Importance of WACC Calculation

Details: WACC is used as a discount rate in discounted cash flow analysis, for evaluating investment opportunities, and as a hurdle rate for capital budgeting decisions. It helps determine the minimum acceptable return on investment.

4. Using the Calculator

Tips: Enter all values as decimals except cost of equity and cost of debt which are percentages. Ensure E/V + D/V = 1 for accurate results. Tax rate should be entered as a decimal (e.g., 0.25 for 25%).

5. Frequently Asked Questions (FAQ)

Q1: What is a good WACC value?
A: A "good" WACC depends on the industry and company risk. Generally, lower WACC indicates cheaper financing, but it should be compared to industry averages and company-specific risk factors.

Q2: How is cost of equity calculated?
A: Cost of equity is typically calculated using CAPM (Capital Asset Pricing Model): Re = Rf + β(Rm - Rf), where Rf is risk-free rate, β is beta, and Rm is market return.

Q3: Why is debt cost tax-adjusted?
A: Interest expenses are tax-deductible, reducing the actual cost of debt to the company, hence the (1-T) multiplier.

Q4: What if E/V + D/V doesn't equal 1?
A: The calculator will still compute WACC, but for accurate corporate finance applications, E/V + D/V should equal total firm value (V = E + D).

Q5: Can WACC be negative?
A: In theory, yes, but practically very rare. Could occur with extremely high cash balances or unusual capital structures, but typically WACC is positive.