Weighted Average Cost of Capital (WACC) Calculator
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Your Weighted Average Cost of Capital (WACC) is:
—Understanding and Calculating WACC
The Weighted Average Cost of Capital (WACC) is a crucial metric used in finance to represent a company's blended cost of capital across all sources, including common stock, preferred stock, bonds, and other forms of debt. It signifies the average rate of return a company expects to pay to its investors to finance its assets. WACC is commonly used to discount future cash flows in discounted cash flow (DCF) analysis and to evaluate the potential profitability of new projects or acquisitions.
The WACC Formula
The standard formula for WACC is:
WACC = (E/V * Re) + (D/V * Rd * (1 - Tc))
Where:
- E = Market Value of the company's Equity
- D = Market Value of the company's Debt
- V = Total Market Value of the company (E + D)
- Re = Cost of Equity
- Rd = Cost of Debt (Pre-Tax)
- Tc = Corporate Tax Rate
Components Explained:
- Market Value of Equity (E): This is typically calculated by multiplying the current stock price by the number of outstanding shares.
- Market Value of Debt (D): This represents the total market value of all outstanding debt, including bonds and loans. If market values are not readily available, book values are often used as an approximation.
- Cost of Equity (Re): This is the return a company requires to issue equity. It's often estimated using models like the Capital Asset Pricing Model (CAPM).
- Cost of Debt (Rd): This is the pre-tax rate a company pays on its current debt. It can be approximated by the yield on the company's outstanding bonds.
- Corporate Tax Rate (Tc): This is the company's effective or marginal tax rate. The cost of debt is tax-deductible, so the formula includes the
(1 - Tc)term to reflect the tax shield benefit.
Why is WACC Important?
- Investment Decisions: Companies use WACC as a hurdle rate. Projects with expected returns higher than WACC are generally considered viable, while those below WACC are typically rejected.
- Valuation: WACC is the discount rate used in DCF models to determine the present value of a company's future cash flows, thereby estimating its intrinsic value.
- Performance Measurement: It can be used to assess whether a company is creating value (i.e., if its return on invested capital exceeds WACC).
WACC Calculator Example:
Let's consider a company with the following financial figures:
- Market Value of Equity (E): $100,000,000
- Market Value of Debt (D): $50,000,000
- Cost of Equity (Re): 12%
- Cost of Debt (Pre-Tax, Rd): 5%
- Corporate Tax Rate (Tc): 25%
First, calculate the total market value of the company: V = E + D = $100,000,000 + $50,000,000 = $150,000,000.
Next, calculate the weights of equity and debt:
- Weight of Equity (E/V) = $100,000,000 / $150,000,000 = 0.6667 (or 66.67%)
- Weight of Debt (D/V) = $50,000,000 / $150,000,000 = 0.3333 (or 33.33%)
Now, plug these values into the WACC formula:
WACC = (0.6667 * 12%) + (0.3333 * 5% * (1 – 0.25))
WACC = (0.6667 * 0.12) + (0.3333 * 0.05 * 0.75)
WACC = 0.0800 + 0.0125
WACC = 0.0925
Therefore, the WACC for this company is 9.25%.
This means the company needs to generate a return of at least 9.25% on its investments to satisfy its investors and maintain its market value. This calculator helps you perform similar calculations efficiently.