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Use the Weighted Average Cost of Capital (WACC) Calculator below to estimate the minimum return a company must earn on its existing asset base to satisfy its creditors and shareholders. Enter the necessary inputs to get an instant calculation.
Calculate the Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC):
Calculate the Cost of Capital Formula
WACC = ($E/V$ * $R_e$) + ($D/V$ * $R_d$ * (1 - $T_c$))
Formula Sources: Investopedia: WACC Definition | CFI: WACC Calculation
Variables
- $R_e$ (Cost of Equity): The return required by equity investors, often derived using the CAPM model.
- $R_d$ (Cost of Debt): The effective interest rate a company pays on its current debt.
- $T_c$ (Corporate Tax Rate): The marginal tax rate of the company.
- $E/V$ (Equity Weighting): The proportion of equity financing to the total capital ($E+D$).
- $D/V$ (Debt Weighting): The proportion of debt financing to the total capital ($E+D$).
What is the Cost of Capital?
The cost of capital, most commonly calculated as the Weighted Average Cost of Capital (WACC), represents a company’s blended cost of financing all its assets. It is the minimum return that a company must earn on a project to justify the use of capital, ensuring that value is created for its investors. If a company generates a return on investment (ROI) greater than its WACC, it is generally considered to be creating value.
WACC takes into account the cost of all sources of capital, including common stock, preferred stock, bonds, and other long-term debt. A crucial component is the tax deductibility of interest payments on debt, which reduces the effective cost of debt financing, hence the $(1 – T_c)$ multiplier in the formula.
How to Calculate the Cost of Capital (Example)
- Gather Components: Assume a Cost of Equity ($R_e$) of 10%, Cost of Debt ($R_d$) of 5%, Tax Rate ($T_c$) of 30%, and an Equity Weighting ($E/V$) of 60%.
- Determine Weights: The Debt Weighting ($D/V$) is automatically 100% – 60% = 40%.
- Calculate After-Tax Cost of Debt: $R_d * (1 – T_c) = 5\% * (1 – 0.30) = 5\% * 0.70 = 3.5\%$.
- Calculate Weighted Cost of Equity: $W_e * R_e = 60\% * 10\% = 6.0\%$.
- Calculate Weighted After-Tax Cost of Debt: $W_d * R_d (1 – T_c) = 40\% * 3.5\% = 1.4\%$.
- Sum the Components (WACC): $WACC = 6.0\% + 1.4\% = 7.4\%$.
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Frequently Asked Questions (FAQ)
Is a lower WACC better for a company?
Generally, yes. A lower WACC indicates that a company can raise capital at a lower cost, giving it a competitive advantage when evaluating potential projects. It means the company has a lower hurdle rate to clear for its investments to be profitable.
What is the main advantage of debt financing in WACC?
The primary advantage is the “tax shield.” Interest expense on debt is tax-deductible, which lowers the company’s taxable income and, therefore, reduces the effective cost of debt capital. This is why the cost of debt is multiplied by $(1 – T_c)$.
How does the Cost of Equity ($R_e$) relate to the CAPM?
The Cost of Equity is typically estimated using the Capital Asset Pricing Model (CAPM), which considers the risk-free rate, the asset’s systematic risk (Beta), and the expected market return.
What happens if the Equity and Debt weightings don’t sum to 100%?
In practice, the weights should always represent the total capital structure. This calculator will normalize the weights if only one is entered, or alert you if the entered weights significantly deviate from 100%.