How to Calculate Weighted Average Cost of Capital - Tutorial

How to Calculate WACC - Definition, Formula and Example

Definition:

Weighted average cost of capital (WACC) is the minimum return which a company is supposed to give on an average to satisfy its entire security proprietors to finance its assets. This tutorial explains you how to calculate Weighted average cost of capital.

Formula:


WACC = (E/V x Re) + [(D/V x Rd) x (1-Tc)] V = E + D
Where,
WACC = Weighted Average Cost of Capital E = Market value of the firm's equity D = Market value of the firm's debt V = Firm Value Re = Cost of Equity Rd = Cost of Debt Tc = Corporate tax rate

Example :

Company Hiox has a beta of 1.65. The current equity market risk premium is 7%, and the risk-free rate is 3%. Its before-tax cost of debt is 6% and its marginal tax rate is 40%. The stock sells at Long-Term Debt 6000 and Equity 1500. Find the WACC percentage of the company.?

Given

Market value of the firm's equity (E) = 1500 Market value of the firm's debt (D) = 6000 Cost of Equity (Re) = 3% + (7% x 1.65) = 14.55% Cost of Debt (Rd) = 6% Corporate tax rate (Tc) = 40%

To Find,

Weighted Average Cost of Capital

Solution:
Step 1 :

Find value of V V = E + D V = 1500 + 6000 = 7500

Step 2 :

WACC = (E/V x Re) + [(D/V x Rd) x (1-Tc)] = (1500/7500 x 0.1455) + [(6000/7500 x 0.06) x (1-0.4)] = 5.79 %

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