Weighted average cost of capital
The weighted average cost of capital (WACC) is the rate that a company is expected to
pay on average to all its security holders to finance its assets aka the god ratio.
The WACC is the minimum return that a company must earn on existing asset base to
satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere.
Companies raise money from a number of sources: common equity, preferred equity,
straight debt, convertible debt, exchangeable debt, warrants, options, pension liabilities,
executive stock options, governmental subsidies, and so on. Different securities are
expected to generate different returns. The WACC is calculated taking into account the
relative weights of each component of the capital structure and is used to see if the
investment is worthwhile to undertake[1].
The more complex the company's capital structure, the more laborious it is to calculate
the WACC.
Contents
1 General formula
2 The formula for a simple case
3 Example
4 References
5 See also
6 External links
General formula
In general, the WACC can be calculated with the formula[2]:
, where N is the number sources of capital
(securities, types of liabilities); ri is the required rate of return for security i; MVi is the
market value of all outstanding securities i.
The formula for a simple case
In a simple case where the company is financed by homogeneous equity and debt, the
weighted average cost of capital can be found through:
, where
, where:
Symbol Meaning Units
required or expected rate of return on equity, or cost of equity %
required or expected rate of return on borrowings before taxes %
risk free rate %
risk premium rate %
Beta coefficient -
corporate tax rate %
total debt and leases (including current portion of long-term debt and
currency
notes payable)
total market value of equity and equity equivalents or market cap
currency
(number of shares outstanding X share price)
total capital invested in the going concern currency
Example
Capital Component Cost x % of capital structure Total
Retained Earnings 8% X 30% 2.4%
Common Stocks 9% X 10% 0.9%
Preferred Stocks 10% X 15% 1.5%
Debt (Bonds) 6.67% X 45% 3.0%
TOTAL 100% 7.8%
The WACC of this company is 7.8%