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					The Weighted Average Cost of Capital
What Does "Cost of Capital" Mean?

"Cost of capital" is defined as "the opportunity cost of all capital invested in an enterprise."

Let's dissect this definition:

  Opportunity cost is what you give up as a consequence of your decision to use a scarce resource
  in a particular way.
  All capital invested is the total amount of cash invested into a business.
  In an enterprise this refers to the fact that we are measuring the opportunity cost of all sources of
  capital which include debt and equity.

How Do We Calculate a Company's Weighted Average Cost of Capital?

We calculate a company's weighted average cost of capital using a 3 step process:

1. Cost of capital components. First, we calculate or infer the cost of each kind of capital that the
enterprise uses, namely debt and equity.

A. Debt capital. The cost of debt capital is equivalent to actual or imputed interest rate on the
company's debt, adjusted for the tax-deductibility of interest expenses. Specifically:

The after-tax cost of debt-capital = The Yield-to-Maturity on long-term debt x (1 minus the marginal
tax rate in %)

We enter the marginal corporate tax rate in the worksheet "WACC."

B. Equity capital. Equity shareholders, unlike debt holders, do not demand an explicit return on their
capital. However, equity shareholders do face an implicit opportunity cost for investing in a specific
company, because they could invest in an alternative company with a similar risk profile. Thus, we
infer the opportunity cost of equity capital.

We can do this by using the "Capital Asset Pricing Model" (CAPM). This model says that equity
shareholders demand a minimum rate of return equal to the return from a risk-free investment plus
a return for bearing extra risk. This extra risk is often called the "equity risk premium", and is
equivalent to the risk premium of the market as a whole times a multiplier--called "beta"--that
measures how risky a specific security is relative to the total market.

Thus, the cost of equity capital = Risk-Free Rate + (Beta times Market Risk Premium).

2. Capital structure. Next, we calculate the proportion that debt and equity capital contribute to the
entire enterprise, using the market values of total debt and equity to reflect the investments on
which those investors expect to earn a minimum return.

3. Weighting the components. Finally, we weight the cost of each kind of capital by the proportion
that each contributes to the entire capital structure. This gives us the Weighted Average Cost of
Capital (WACC), the average cost of each dollar of cash employed in the business.
Case Study: Gateway Construction Pty Ltd. (India)

To demonstrate how to calculate a company's cost of capital, we will use the Gateway case study.

1. Cost of capital components. Gateway draws upon two major sources of capital from the capital
markets: debt and equity.

A. Cost of debt capital. Gateway had debt of $8.5 million. Enter this figure in the appropriate cell of
worksheet "WACC."

Our first step in calculating any company's cost of capital is to consult the relevant annual report.
This document tells us that Gateway has two components to its total debt of $8.5 million:

 Regular debt.
 Capital leases. Gateway also has "capital leases." A capital lease is a debt-like agreement in
 which a firm agrees to pay fixed amounts to someone who leases them land or equipment. \

Because there are two kinds of debt with different interest rates, we have to weight the different
interest rates associated with each kind of debt by the relevant proportion of debt that each
comprises. In this case, the weighted pre-tax cost of debt would be equivalent to 11.5%. Enter the
pre-tax cost of debt in cell C5 of worksheet "WACC."
However, we are not done yet. We noted above that we have to adjust for the tax-deductibility of
interest expenses, which lowers the cost of debt according to the following formula:

After-Tax Cost of Debt Capital = The Yield-to-Maturity on long-term debt x (1 minus the marginal
tax rate)
Given Gateway's marginal tax rate of 30%, the company's after-tax cost of debt equates to 11.5% x
(100% minus 30%), or 8.1%. We see this calculation in the worksheet "WACC."

Please note that in this example, we have used a company's actual cost of debt as a proxy for its
marginal cost of long-term debt. A company's marginal cost of long-term debt may be better
estimated by summing the risk-free rate and the "credit spread" that lenders would charge a
company with a specific credit rating.

B. Cost of equity capital. We noted above that:

Cost of Equity Capital = Risk-Free Rate + (Beta times Market Risk Premium).

To calculate any company's cost of equity capital, we need to find a reliable source for each of
these inputs:

1. Risk-free Rate. We suggest using the rate of return on long-term (ten-year) US government
treasury bonds as a proxy for the risk-free rate. (Or German Bunds for Euros). We enter this data
point in cell C4 of worksheet "WACC."

Sources for this include: - the Financial Times web site
2. Beta coefficient. We enter this data point in cell C8 of worksheet "WACC."

In this case we have selected the industry beta for "Building - Heavy Construction" from the the
worksheet "Industry Betas, obtained from Enter 1.66 for Gateway's beta.

There are a variety of sources available for obtaining the beta coefficient for a particular company.

 Yahoo. Yahoo offers free beta estimates through its Company Profile service. Click here to see
 Gateway's Company Profile on Yahoo.
 Bloomberg. Free beta estimates from Bloomberg can be accessed online. Bloomberg's estimate
 of Gateway's current beta can be accessed here. for industry betas - helpful for private companies and emerging markets

3. Equity Risk Premium. Forward looking approaches, as well as more recent historical data,
suggest an equity risk premium in the 3 to 5 percent range. Additional factors can raise this, as
noted below. We use an Equity Risk Premium estimate of 7.5% for this family-dominated Indian
company. We enter this data point in cell C7 of worksheet "WACC."

In addition to the calculated risk premium, additional required return may be needed for:
- Private equity illiquidity risk
- Minority shareholding/corporate governance risk premium
- Country risk

For those interested in looking at historical equity risk premia, we refer you to the following online

 Ibbotson Associates. Ibbotson sells a report on historical risk premia over time on its website. The
 report can be purchased.
 Aswath Damodaran. Valuation expert Professor Damodaran of NYU's Stern School of Business
 has published data as well as an informative article on equity risk premia that can be downloaded
 free of charge.

To continue with our Gateway case study, we used the following estimates for these three factors:

 Risk-free rate of 4%.
 Beta coefficient of 1.66.
 Equity risk premium of 7.5%.

Using these estimates, Gateway's cost of equity capital = Risk-Free Rate + (Beta times Market Risk
Premium).= 4.00% + (1.66 x 7.5%), or 16.5%. We see this calculation in the results section of
worksheet "WACC."

3. Weighting the components. Finally, we weight the cost of each kind of capital by the proportion
that each kind of capital contributes to the entire enterprise. This gives us the Weighted Average
Cost of Capital (WACC), the average cost of each dollar of cash employed in the business.
To review, Gateway's after-tax cost of debt is 8.1% and its cost of equity is 16.5%. The market
value of Gateway's debt is equal to $8.5 million and the market value of Gateway's equity is $45
million. The value of equity can be obtained from the shares outstanding and share price in cells
C12 and C13 in worksheet "WACC." Alternatively, for private companies, the value of the business
may be computed using comparables or a valuation model.

Gateway's weighted average cost of capital is thus 8.1% x 15.9% + 16.5% x 84.1% = 15.1%. You
can see this calculation in worksheet "WACC."

By Ian Giddy
Available as spreadsheet WACC_tutorial.xls on
Acknowledgement: Adapted from
Inputs for WACC Calculation:

Risk free rate (%)                       4.00%
Yield-to-Maturity of debt (%)           11.50%

Equity risk premium (%)                 7.50%
Beta of equity                            1.66

Corporate tax rate (%)                    30%

Common shares (MM)                       10.0
Share price ($)                     $    4.50

Market value of debt ($, MM)        $     8.5

Weighted Average Cost of Capital (WACC) Calculation

                          Debt                                                Equity                                    Total
Pre-tax cost of debt (%)                11.5%
After-tax cost of debt (%)               8.1%          Cost of equity (%)                    16.5%

Market value of debt ($, MM)        $     8.5          Market value of equity ($, MM)    $   45.0    Enterprise Value ($, MM)           $    53.5

Percent of enterprise value (%)         15.9%          Percent of enterprise value (%)       84.1%   Percent of enterprise value (%)        100.0%

                                  Weighted Average Cost of Capital (WACC, %)                                                    15.1%
Industry Betas (these data can be updated from

Industry                                  Beta
Advanced Materials/Prd                     1.51
Advertising Agencies                       1.09
Advertising Sales                          0.25
Advertising Services                       1.64
Aerospace/Defense                          0.97
Aerospace/Defense-Equip                    1.44
Agricultural Biotech                       1.11
Agricultural Chemicals                     1.28
Agricultural Operations                    1.40
Air Pollution Control Eq                   1.04
Airlines                                   1.34
Airport Develop/Maint                      0.99
Apparel Manufacturers                      1.11
Appliances                                 1.29
Applications Software                      1.07
Athletic Equipment                         1.06
Athletic Footwear                          1.01
Audio/Video Products                       1.14
Auto Repair Centers                        1.87
Auto-Cars/Light Trucks                     1.33
Auto-Med&Heavy Duty Trks                   1.31
Auto/Trk Prts&Equip-Orig                   1.13
Auto/Trk Prts&Equip-Repl                   1.01
B2B/E-Commerce                             0.76
Batteries/Battery Sys                      1.02
Beverages-Non-alcoholic                    0.88
Beverages-Wine/Spirits                     1.13
Bicycle Manufacturing                      1.71
Bldg Prod-Air&Heating                      1.18
Bldg Prod-Cement/Aggreg                    1.32
Bldg Prod-Doors&Windows                    1.86
Bldg Prod-Wood                             1.49
Bldg-Mobil Home/Mfd Hous                   1.40
Bldg-Residential/Commer                    1.70
Bldg&Construct Prod-Misc                   1.19
Blood Collection Banking                    NA
Brewery                                    0.88
Broadcast Serv/Program                     1.23
Building-Heavy Construct                   1.66
Building-Maint&Service                     1.80
Building&Construct-Misc                    1.65
Cable TV                                   0.68
Capacitors                                 1.52
Casino Hotels                              1.11
Casino Services                            1.53
Cellular Telecom                           1.16
Ceramic Products                           1.15
Chemicals-Diversified                      1.23
Chemicals-Fibers                           1.56
Chemicals-Other            1.48
Chemicals-Plastics         1.31
Chemicals-Specialty        1.23
Circuit Boards             1.34
Circuits                   1.60
Closed-end Funds           0.33
Coal                       1.34
Coatings/Paint             0.97
Coffee                     0.82
Collectibles               0.70
Commer Banks Non-US        1.33
Commercial Serv-Finance    0.97
Commercial Services        0.98
Communications Software    0.85
Computer Aided Design      2.05
Computer Data Security     1.45
Computer Graphics          1.38
Computer Services          1.02
Computer Software          1.36
Computers                  1.53
Computers-Integrated Sys   1.20
Computers-Memory Devices   1.51
Computers-Other            1.03
Computers-Peripher Equip   1.36
Consulting Services        1.28
Consumer Products-Misc     1.54
Containers-Metal/Glass     1.09
Containers-Paper/Plastic   1.05
Cooperative Banks          1.03
Cosmetics&Toiletries       1.00
Cruise Lines               0.67
Crystal&Giftware           0.53
Data Processing/Mgmt       1.27
Decision Support Softwar   0.90
Dental Supplies&Equip      0.41
Derivatives                 NA
Diagnostic Equipment       1.05
Diagnostic Kits            2.07
Diamonds/Precious Stones   1.21
Direct Marketing            NA
Disposable Medical Prod    1.00
Distribution/Wholesale     1.26
Divers Oper/Commer Serv    1.44
Diversified Finan Serv     1.39
Diversified Manufact Op    1.48
Diversified Minerals       1.55
Diversified Operations     1.49
Drug Delivery Systems      0.77
E-Commerce/Products        1.30
E-Commerce/Services        1.18
E-Services/Consulting      1.36
Educational Software       1.21
Electric Products-Misc     1.15
Electric-Distribution      1.28
Electric-Generation        1.34
Electric-Integrated        1.17
Electric-Transmission      1.38
Electronic Compo-Misc      1.33
Electronic Compo-Semicon   1.55
Electronic Connectors      1.51
Electronic Design Automa   1.55
Electronic Measur Instr    1.19
Electronic Parts Distrib   1.47
Electronic Secur Devices   1.41
Electronics-Military       1.32
Energy-Alternate Sources   1.44
Engineering/R&D Services   1.64
Engines-Internal Combust   1.41
Enterprise Software/Serv   1.32
Entertainment Software     1.68
Environ Consulting&Eng     1.14
Explosives                 1.37
Extended Serv Contracts    0.94
Feminine Health Care Prd   0.30
Filtration/Separat Prod    0.74
Finance-Auto Loans         0.91
Finance-Commercial         1.17
Finance-Consumer Loans     0.97
Finance-Credit Card        0.48
Finance-Invest Bnkr/Brkr   1.97
Finance-Investment Fund    0.48
Finance-Leasing Compan     1.24
Finance-Mtge Loan/Banker   1.18
Finance-Other Services     1.39
Firearms&Ammunition        2.11
Fisheries                  1.29
Food-Baking                1.03
Food-Canned                0.94
Food-Catering              0.96
Food-Confectionery         1.12
Food-Dairy Products        1.02
Food-Flour&Grain           1.42
Food-Meat Products         1.15
Food-Misc/Diversified      1.21
Food-Retail                1.04
Food-Wholesale/Distrib     1.17
Footwear&Related Apparel   0.91
Forestry                   1.39
Funeral Serv&Rel Items     1.13
Gambling (Non-Hotel)       1.75
Gas-Distribution           1.03
Gas-Transportation          NA
Gold Mining                1.52
Golf                       0.93
Hazardous Waste Disposal   1.51
Health Care Cost Contain   3.96
Healthcare Safety Device   1.10
Home Decoration Products   1.16
Home Furnishings           0.87
Hospital Beds/Equipment    0.72
Hotels&Motels              1.15
Housewares                 0.84
Human Resources            1.53
Identification Sys/Dev     1.48
Import/Export              1.60
Inactive/Unknown           1.34
Independ Power Producer    1.18
Industr Audio&Video Prod   1.09
Industrial Automat/Robot   1.23
Industrial Gases           1.36
Instruments-Controls       1.28
Instruments-Scientific     1.39
Insurance Brokers          0.95
Interior Design/Architec   1.05
Internet Applic Sftwr      1.42
Internet Brokers           1.35
Internet Connectiv Svcs    1.09
Internet Content-Entmnt    1.67
Internet Content-Info/Ne   0.79
Internet Gambling          1.05
Internet Incubators        3.56
Internet Infrastr Equip    1.28
Internet Infrastr Sftwr    0.70
Internet Security          1.27
Internet Telephony         1.60
Intimate Apparel           0.87
Invest Comp - Resources    1.87
Invest Mgmnt/Advis Serv    1.18
Investment Companies       1.41
Lasers-Syst/Components     1.52
Leisure&Rec Products       1.27
Leisure&Rec/Games          3.29
Life/Health Insurance      1.19
Lighting Products&Sys      1.69
Linen Supply&Rel Items      NA
Lottery Services           1.67
Mach Tools&Rel Products    1.41
Machinery-Constr&Mining    1.36
Machinery-Electric Util    1.39
Machinery-Electrical       1.16
Machinery-Farm             1.61
Machinery-General Indust   1.37
Machinery-Material Handl   1.60
Machinery-Print Trade      1.42
Machinery-Pumps            1.13
Machinery-Therml Process   1.55
Marine Services            1.65
Medical Imaging Systems    1.31
Medical Information Sys    1.00
Medical Instruments        1.59
Medical Labs&Testing Srv   1.04
Medical Laser Systems       NA
Medical Products           1.41
Medical Steriliz Product   1.32
Medical-Biomedical/Gene    1.10
Medical-Drugs              1.13
Medical-Generic Drugs      1.11
Medical-HMO                 NA
Medical-Hospitals          0.87
Medical-Outptnt/Home Med   0.93
Medical-Whsle Drug Dist    1.18
Metal Processors&Fabrica   1.53
Metal Products-Distrib     1.50
Metal Products-Fasteners   1.07
Metal-Aluminum             1.50
Metal-Copper               1.18
Metal-Diversified          1.53
Metal-Iron                 1.25
Mining Services            1.21
Miscellaneous Manufactur   1.21
Money Center Banks         0.72
Mortgage Banks             1.57
Motion Pictures&Services   1.27
Motorcycle/Motor Scooter   1.23
Multi-line Insurance       1.17
Multilevel Dir Selling     0.68
Multimedia                 1.16
Music                      1.04
Networking Products        1.60
Non-Ferrous Metals         1.90
Non-hazardous Waste Disp   1.39
Not classified             0.91
Office Automation&Equip    1.56
Office Furnishings-Orig    0.92
Office Supplies&Forms      1.73
Oil Comp-Explor&Prodtn     1.59
Oil Comp-Integrated        1.46
Oil Field Mach&Equip       2.18
Oil Refining&Marketing     1.31
Oil-Field Services         1.71
Oil&Gas Drilling           1.68
Optical Supplies           0.73
Paper&Related Products     1.16
Pastoral&Agricultural      1.20
Patient Monitoring Equip   1.39
Petrochemicals             1.33
Pharmacy Services           NA
Photo Equipment&Supplies   1.56
Phys Practice Mgmnt        1.30
Pipelines                  1.42
Platinum                   1.75
Pollution Control          1.18
Poultry                    1.06
Power Conv/Supply Equip    1.47
Precious Metals            1.52
Printing-Commercial        1.16
Professional Sports        0.46
Property Trust             0.45
Property/Casualty Ins      1.29
Protection-Safety          0.78
Public Thoroughfares       1.28
Publishing-Books           0.76
Publishing-Newspapers      1.05
Publishing-Periodicals     0.91
Quarrying                  1.02
Racetracks                 0.38
Radio                      0.76
Real Estate Mgmnt/Servic   1.30
Real Estate Oper/Develop   1.56
Recreational Centers       1.00
Recycling                  1.32
Regional Banks-Non US      1.15
Reinsurance                0.96
Remediation Services       0.78
Rental Auto/Equipment      1.29
Research&Development       2.55
Resorts/Theme Parks        1.09
Respiratory Products       0.63
Retail-Apparel/Shoe        1.20
Retail-Appliances          1.15
Retail-Auto Parts          0.36
Retail-Automobile          1.17
Retail-Bookstore            NA
Retail-Building Products   1.09
Retail-Catalog Shopping    2.28
Retail-Computer Equip      1.26
Retail-Consumer Electron   1.06
Retail-Convenience Store   0.93
Retail-Discount            0.81
Retail-Drug Store          1.28
Retail-Hair Salons         0.87
Retail-Home Furnishings    1.16
Retail-Hypermarkets        0.81
Retail-Jewelry             1.17
Retail-Major Dept Store    1.43
Retail-Misc/Diversified    1.29
Retail-Office Supplies     1.04
Retail-Perfume&Cosmetics   1.03
Retail-Petroleum Prod      1.15
Retail-Regnl Dept Store    1.21
Retail-Restaurants         1.00
Retail-Sporting Goods       NA
Retail-Toy Store           1.59
Rubber-Tires               1.30
Rubber/Plastic Products    1.21
Rubber&Vinyl               1.29
Satellite Telecom          1.07
Schools                    1.13
Security Services          1.63
Seismic Data Collection    1.05
Semicon Compo-Intg Circu   1.71
Semiconductor Equipment    1.33
Shipbuilding               1.82
Silver Mining              1.05
Soap&Cleaning Prepar       1.07
Special Purpose Banks      0.78
Special Purpose Entity     0.68
Specified Purpose Acquis   0.34
Steel Pipe&Tube            1.39
Steel-Producers            1.53
Steel-Specialty            1.48
Stevedoring                1.13
Storage/Warehousing        1.29
Sugar                      1.25
Superconductor Prod&Sys    1.54
Tannery                    0.91
Tea                        1.29
Telecom Eq Fiber Optics    1.29
Telecom Services           1.26
Telecommunication Equip    1.38
Telephone-Integrated       1.03
Television                 1.24
Textile-Apparel            1.19
Textile-Home Furnishings   0.67
Textile-Products           1.24
Theaters                   1.32
Therapeutics               1.17
Tobacco                    0.86
Tools-Hand Held            1.36
Toys                       1.10
Transactional Software     1.37
Transport-Air Freight      0.95
Transport-Equip&Leasng     0.79
Transport-Marine           1.54
Transport-Rail             0.97
Transport-Services         1.24
Transport-Truck            1.41
Travel Services            1.09
Venture Capital            1.36
Veterinary Diagnostics     1.39
Veterinary Products        1.42
Vitamins&Nutrition Prod    1.59
Water                      1.11
Water Treatment Systems    1.41
Web Hosting/Design         1.46
Web Portals/ISP            1.52
Whsing&Harbor Trans Serv   0.95
Wire&Cable Products        1.44
Wireless Equipment         1.54
Wool                        NA
Wound,Burn&Skin Care       1.64
X-Ray Equipment            1.49
Data   From Aswath Damodaran's web site,
       Data Sets                                         Excel file         Archived Data
       Historical Returns on Stocks, Bonds and Bills -   Download
       United States

       Implied Equity Risk Premiums - United States      Download

       Risk Premiums for Other Markets                   Download 2000, 2001, 2002, 2003,
                                                                  2004, 2005 , 2006

       Levered and Unlevered Betas by Industry           U.S.         1998, 1999, 2000, 2001,
                                                                      2002, 2003. 2004 , 2005 ,

       Marginal tax rate by country                      Download

       Total Beta By Industry Sector                     Download 1998, 1999, 2000, 2001,
                                                                  2002, 2003, 2004 , 2005 ,

       Risk Measures by Market Cap Class                 Download

       Costs of Capital by Industry Sector               Download 1998, 1999, 2000, 2001,
                                                                  2002, 2003 , 2004 , 2005 ,
This data set includes actual returns on stocks, bonds and bills for the United States from
1928 to the most recent year. It is a useful starting point for estimating historical equity

These risk premiums are estimated based upon a simple 2-stage Dividend discount model
and reflect the risk premium which would justify they current level of the index, given the
dividend yield, expected growth in earnings and the level of the long term bond rate.

These are risk premiums estimates for other markets based upon the country ratings
assigned by Standard and Poors'.

This data set lists betas by industrial sector. The betas are computed using 5 years of
monthly returns for each stock and then averaged (simple). The unlevered betas are
estimated using the average market debt/equity ratios by industrial sector. (Hamada betas).

This is the KPMG survey of corporate tax rates by country. Please give them full credit
when you use any of the information from this file.
These are betas adjusted to reflect a firm's total exposure to risk rather than just the market
risk component. It is a function of the market beta and the portion of the total risk that is
market risk. These betas might provide better estimates of costs of equity for undiversified
owners of businesses.

These are risk measures - standard deviatiions, betas, total betas and hilo risk - broken
down for U.S. firms into ten market cap classes. Make of it what you will.
This data set lists costs of equity, costs of debt, market debt ratios and costs of capital by
industrial sector.

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