Financial modelling terms explained

# Weighted Average Cost of Capital

The weighted average cost of capital (WACC) is the cost of a company's capital structure, made up of equity and debt, which is used to calculate the cost of equity. WACC is an important measure of profitability and is often used in capital budgeting decisions

## What Is Weighted Average Cost of Capital?

Weighted average cost of capital (WACC) is the average cost of all financing sources used by a company. This includes both debt and equity. The weighting is determined by the respective proportions of each source of finance. The cost of each source is then multiplied by its weight to calculate the WACC.

The WACC is an important number for companies as it affects the return that shareholders require on their investment. The higher the WACC, the more expensive it is for a company to raise capital and, as a result, the lower the return that shareholders can expect.

There are a number of factors that can affect a company's WACC. The most significant are the cost of debt and the cost of equity. The cost of debt is the interest rate that a company pays on its debt financing. The cost of equity is the rate of return that shareholders require on their investment in the company.

Other factors that can affect the WACC include the company's tax rate and the amount of debt financing that it uses.

## How Do You Calculate Weighted Average Cost of Capital?

Weighted average cost of capital (WACC) is a calculation of the average cost of all of a company's capital resources. This includes both debt and equity. The calculation takes into account the relative weight of each type of capital. The WACC calculation uses the following formula:

WACC = (E/V x Re) + (D/V x Rd)

Where:

E = the market value of the company's equityD = the market value of the company's debtV = the total value of the companyRe = the required rate of return on equityRd = the required rate of return on debt

## How Do You Calculate Weighted Average Cost of Capital for a Company?

The weighted average cost of capital (WACC) is a calculation used to determine the average cost of capital for a company. The calculation takes into account the company's debt and equity mix, and the cost of each type of capital. The WACC is used to determine the company's cost of capital, which is the rate of return that the company would need to earn on its investments to break even.

There are a few different ways to calculate the WACC, but the most common method takes into account the following factors:

Debt: The cost of debt is the interest rate that the company pays on its debt.

Equity: The cost of equity is the rate of return that investors require on their equity investments in the company.

Tax Rate: The tax rate is the rate of tax that the company pays on its income.

Debt to Equity Ratio: The debt to equity ratio is the ratio of the company's debt to its equity.

The weighted average cost of capital can be calculated using the following formula:

WACC = (Debt x Cost of Debt) / (Debt + Equity) x (1 - Tax Rate) + (Equity x Cost of Equity)

For example, if a company has \$10,000 of debt outstanding with an interest rate of 8%, \$20,000 of equity outstanding with a required rate of return of 12%, and a tax rate of 30%, the WACC would be calculated as follows:

WACC = (10,000 x 8%) / (10,000 + 20,000) x (1 - 30%) + (20,000 x 12%)

WACC = 6.4%

## What Is the Difference Between Weighted Average Cost of Capital and Cost of Capital?

The weighted average cost of capital (WACC) is the average rate of return that a company expects to earn on its weighted average capital. The weighted average capital is the average of the company's debt and equity. The cost of capital is the rate of return that a company would require on new investments to maintain its current market value.

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