Moneyzine
Contents
/Investment Guides /Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC)

Moneyzine Editor
Author: 
Moneyzine Editor
4 mins
September 21st, 2023
Advertiser Disclosure

Definition

The financial investing term weighted average cost of capital is used to describe the average cost of financing the capital investments of a company. The weighted average cost of capital calculation takes the percentage of financing derived from each source of funds, and multiplies it by the opportunity cost.

Calculation

Weighted Average Cost of Capital = (S1 x W1) + (S2 x W2) + (S3 x W3)...

Where:

  • Sn = the opportunity cost associated with each of the various sources of capital financing, including common and preferred stock as well as debt.

  • Wn = the percentage of the company's total financing derived from each source.

Explanation

Generally, the assets of a company are financed through equity or debt, which includes common stocks as well as bonds. In the case of regulated utilities, preferred stock may also play a role in financing assets. A company's weighted average cost of capital, or WACC, is calculated by taking the cost of each source of financing and multiplying it by its share of the total financing of the company.

When evaluating the economic feasibility of an investment, a company will typically use its WACC to discount future cash flows. For example, if a business segment were to propose a new capital project, the company's WACC would be used as the discount rate when determining the present value of the project's future cash flows. If the net present value of the project is greater than zero, then the benefits associated with the project would be greater than its financing cost.

The cost and weight of each component is determined as outlined in the following sections.

Equity

The total value of equity issued by a company is the number of shares outstanding multiplied by the price per share as shown below. This approach can be applied to common stock as well as any preferred shares issued to the marketplace.

Market Value of Equity = Price per Share x Shares Outstanding

The cost of equity is found by taking the risk-free rate and multiplying it by the stock's beta and adding to this value a risk premium. The risk premium is the expected rate of return for the stock, or capital project, in excess of the risk-free interest rate. This is sometimes referred to as an equity premium.

Cost of Equity = (Risk Free Rate x Stock Beta) + Risk Premium

Debt

The formula for finding the value of debt is fairly complex, requiring knowledge of the book value of the company's debt, the annual interest expense, the average maturity of the company's debt, as well as its pre-tax cost. A formula for determining the value of debt appears below: Market Value of Debt = E x (1 - (1 + P)-M) / P + B / (1+P)M

Where:

  • B = Book Value of Debt ($)

  • E = Interest Expense on Debt ($)

  • M = Average Maturity of Debt (Years)

  • P = Pre-tax Cost of Debt (% / Year)

The cost of debt is found by taking its pre-tax cost and multiplying it by 1 minus the company's tax rate as shown below:

Cost of Debt = P x (1 - T)

Where:

  • P = Pre-tax Cost of Debt (% / Year)

  • T = Effective Tax Rate (%)

Example

Company A currently has 250,000,000 shares of common stock outstanding. The current market price of Company A's shares is $23.50, and the stock's beta is 1.05. The current risk-free rate of interest is 4.50%, and the risk premium for this project is 4.00%. The book value of Company A's debt is $5,000,000,000. The income statement indicates interest expense of $600,000,000, and an average maturity of ten years. Company A's pretax cost of debt is 6.50% per year and its tax rate is 40%.

The solution to the above example can be found using our Weighted Average Cost of Capital Calculator, which uses the formulas outlined in the above sections.

Related Terms

beta, interest expense, book value

Explore Investing Further

Trading has never been easier, thanks to the rise of online platforms that enable you to buy and sell various assets at the click of a button. But with so many options available, it can be challenging to decide which platform is right for you.
Looking for a way to avoid swap fees while trading forex?
Below listed are the small reviews of the top 10 ETF brokers available across the United States.
Our top beginner's pick for copy trading is eToro. Read on for more details, plus seven good alternatives.
Swing trading stocks can be a great way for investors to take advantage of short-term stock market movements and gain significant returns. If you're interested in swing trading, the key to success lies in selecting the right stocks to buy and sell quickly for a profit.
The table below lists the best stock picks under $2, listed on public exchanges.
The table below lists the best stock picks under $1, listed both on public and OTC exchanges.
This section will highlight the best EV-trading penny stocks available in the United States.
The demand for sustainable energy has grown rapidly in recent years. This has resulted in increased scrutiny of the automotive market. As a result, the electric vehicle (EV) industry has made significant advancements.
Intelligent Bio Solutions Inc. is a life sciences company, founded in 2016 with headquarters in New York and is engaged in performing diagnostic tests, real-time monitoring, and non-invasive surgery for its patients. The firm has developed a CoV-2 Biosensor, which can be used in RNA virus detection.
Hour Loop was founded in 2013 with headquarters in Redmond, Washington. It’s an online retailer involved in e-commerce in the United States that hit the public markets on Jan 7th of 2022. The company sells home/garden decor, electronic products, kitchenware, and apparel through walmart.com, amazon.com, and hourloop.com.

Related Content

Biden Or Trump: Who Is Better For The Economy And Stocks?
Yup. This is one of those articles. It's an election year, and here in the U.S., we get to decide which old dude who’s been alive long enough to remember when there were only 48 states in the U.S. will be the leader of the free world.
March 19th, 2024
When it comes to strategic business planning, accounting is front and center, shaping the course of action. At least it should be.
March 14th, 2024
DRIP Brokers: Best Brokers for Dividend Investing for March 2024
Reinvesting dividends could mean compound growth for your portfolio. But reinvesting them manually can be a hassle. This is why you could benefit from a dividend reinvestment plan (DRIP).
March 12th, 2024
How To Invest in Real Estate Without Becoming a Landlord
We all know that in order to build wealth and prepare for retirement, investing is the key. However, it can be hard to figure out what to invest in and how to put your money to good use. One of the most talked about ways to build wealth is owning property and being a landlord to bring in passive income. But what if you don’t want to do that? You can still invest in real estate!
March 6th, 2024
Investing In Nature: The Closest You'll Get To Your Money Growing On Trees
ESG (Environmental, Social, and Governance) has become a polluted word for many traders and investors - but that doesn't mean it's going completely away. Nor does that mean you can't profit from nature or sustainable practices. But there are some opportunities in the regenerative ag, conservation, and green real estate spaces.
February 29th, 2024

Contributors

Moneyzine 2024. All Rights Reserved.