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Weighted Average Cost of Capital

The document defines and explains weighted average cost of capital (WACC). It states that WACC is a calculation that weights the cost of all sources of capital, including common stock, preferred stock, bonds, and debt. It is the rate a company is expected to pay on average to its security holders. The sources of capital and their respective costs are used to calculate WACC using a specified formula. Calculating WACC is important for companies to evaluate the cost of funding future projects and determine how to lower their cost of capital.

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80 views

Weighted Average Cost of Capital

The document defines and explains weighted average cost of capital (WACC). It states that WACC is a calculation that weights the cost of all sources of capital, including common stock, preferred stock, bonds, and debt. It is the rate a company is expected to pay on average to its security holders. The sources of capital and their respective costs are used to calculate WACC using a specified formula. Calculating WACC is important for companies to evaluate the cost of funding future projects and determine how to lower their cost of capital.

Uploaded by

Barkkha Makhija
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Weighted Average Cost Of

Capital
WACC
What is 'Weighted Average Cost Of
Capital
- WACC'

 Weighted Average Cost Of Capital (WACC) is a calculation of a


firm's cost of capital in which each category of capital is
proportionately weighted.
 Weighted Average Cost Of Capital (WACC) is the rate that a
company is expected to pay on average to all its security holders to
finance its assets.
Sources of Capital
 All sources of capital, including :
 common stock
 preferred stock
 Bonds
 any other long-term debt
are included in a WACC calculation. A firm’s WACC
increases as the beta and rate of return on equity increase,
as an increase in WACC denotes a decrease in valuation
and an increase in risk.
Why it Matters

 It's important for a company to know its weighted average cost of


capital as a way to gauge the expense of funding future projects. The
lower a company's WACC, the cheaper it is for a company to fund
new projects.

 A company looking to lower its WACC may decide to increase its use
of cheaper financing sources.
Calculate WACC

 To calculate WACC, multiply the cost of each capital


component by its proportional weight and take the sum
of the results. The method for calculating WACC can be
expressed in the following formula:
Calculation of Simple WACC

WACC =(Cost of equity *%of Equity)+ (cost of Pref.capital*%of Pref Capital)+(cost of Debt*%of Debt)

WACC Can also be calculated on the basis of:


1.Book Value 
2.Market Value
Extra Solved sums
A firm has the following capital structure and after-tax costs for the different sources
of funds used:
You are required to compute the weighted average cost of capital

Solution:
The following is the capital structure of a company:

The current market price of the company’s equity share is Rs. 200. For the
last year the company had paid equity dividend at 25 per cent and its
dividend is likely to grow 5 per cent every year. The corporate tax rate is 30
per cent and shareholders personal income tax rate is 20 per cent.
You are required to calculate:
(i) Cost of capital for each source of capital.
(ii) Weighted average cost of capital on the basis of book value weights.
(iii) Weighted average cost of capital on the basis of market value weights.
Solution:
THANK
YOU

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