WACC

Knowledge Center

What is the WACC? Definition

Corporations create value for shareholders by earning a return on the invested capital that is above the cost of that capital. WACC (Weighted Average Cost of Capital) is an expression of this cost. It is used to see if value is added when certain intended investments or strategies or projects or purchases are undertaken.

WACC is expressed as a percentage, like interest. For example, if a company works with a WACC of 12%, than this means that only investments should be made and all investments should be made, that give a return higher than the WACC of 12%. 

The costs of capital for any investment, whether for an entire company or for a project, is the rate of return which capital providers would want to receive if they would invest their capital elsewhere. In other words, costs of capital are a type of opportunity cost.

Calculation of WACC. Formula

The easy part of WACC is its debt part. In most cases it is clear how much a company has to pay their bankers or bond holders for debt finance. More difficult however, is the cost of equity finance. Normally, the cost of equity capital is higher than the cost debt finance, because equity involve a risk premium. See also: Cost of Capital.

Factors that make calculating WACC difficult:

1. Calculating this risk premium is one thing that makes the calculation of WACC complicated.
2. Another important complication is which mix of debt and equity should be used to maximize shareholder value. This is what "Weighted" means in WACC.
3. Finally: also the corporate tax rate is important, because normally interest payments are tax deductible.

The WACC formula:

       Debt / TF (cost of debt)(1-Tax)

+     Equity / TF (cost of equity)

-------------------------------------------------

       WACC

In this formula,

• TF means Total Financing. Total Financing consists of the sum of the market values of debt and equity finance. An important issue with TF is whether, and under what circumstances, it should include current liabilities, such as trade credit. In valuing a company this is relevant, because:
  • Trade credit is used aggressively by many companies.
  • There is an interest (or financing) charge for such use.
  • Trade credit can be a large amount on the balance sheet.
• Tax stands for the corporate tax rate.

Example of WACC calculation.

Suppose the following situation in a company:

The market value of debt = €300 million
The market value of equity = €400 million
The cost of debt = 8%
The corporate tax rate = 35%
The cost of equity is 18%
 

The WACC of this company is:

     300 : 700 * 8% * (1-35%)

+   400 : 700 * 18%

------------------------------------------------

     12,5% (WACC - Weighted Average Cost of Capital)

Forum Forum discussions about WACC. Calculating WACC | WACC Calculation Example I have been asked to calculate the WACC using the following info: Capital structure: Ordinary shares (fully paid) :1000000, preference shares: (11%) 400000, debentures: (10%) 600000. The ordinary shar... 17   8 comments Importance of WACC for Companies? What are the importances of WACC to a quoted or an unquoted organisation? Thanks.... 8   2 comments 🔥 Weighted Marginal Cost of Capital Dear Friends, kindly, I need your support to get more knowledge about Weighted Marginal Cost of Capital. What is meant with that and what is the difference with WACC?... 6   3 comments Why Calculation of WACC is Difficult. Problems One reason why calculating WACC is difficult is that determining the relevant risk premium is tricky. It's a tricky issue to calculate the most relevant risk premium required for the calculation of th... 4   1 comments Start a new topic about WACC Sign up for free

Courses about WACC. Beginners Course Advanced Course Course for Experts

Expert Tips Advanced insights about WACC. Here you will find professional advices by experts. Consultancy Tips Teaching Tips Practical Implementation Tips

Information Sources Various sources of information regarding WACC. Here you will find powerpoints, videos, news, etc. to use in your own lectures and workshops. WACC Calculation Including all of its Components Calculation of WACC, Calculation of Cost of Capital, Calculation of Cost of Equity, Calculation of Cost of Debt This superb explanation establishes a solid initial understanding of: - Cost of Capital - Cost of Equity - Cost of De... WACC User Guide Estimation of capital costs The estimation of corporate capital costs is complicated by many practical issues that create numerous degrees of freedo... Top-9 CF Valuation Mistakes Cost of capital, WACC, valuati In cash flow valuation (CFV), there are two main categories of mistakes: derivation of the appropriate cash flows and es... Top 9 Unnecessary and Avoidable Mistakes in Cash Flow Valuation Current Cost of Capital, WACC, Valuation Estimate the current cost of capital for your firm. Spreadsheet by Aswath Damodaran.... Corporate Valuation for Businesses Corporate Valuation, Book Value, Market Value, Intrinsic Value, Fundamental Value, M&A, VBM, Fundamental Investing Presentation that elaborates on corporate valuation, including the following sections: 1. Three types of value: - Book...

Tools Useful tools regarding WACC. News Videos Presentations   Books Academic More

Compare with WACC: Cost of Capital  |  Internal Rate of Return  |  Net Present Value |  Discounted Cash Flow  |  Cost of Equity

Return to Management Hub: Decision-making & Valuation  |  Finance & Investing

More Management Methods, Models and Theory