CALCULATION OF WEIGHTED AVERAGE COST OF CAPITAL (WACC)

By: Anshuman Satapathy

What is WACC ?
A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. We can calculate WACC using the formula:WACC= (E/ V) *Ke + (D/ V) * Kd * (1-Tc) Where:

Ke = cost of equity Kd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate

Example:
Sharma Builders has a cost of equity of 15%, before-tax cost of debt of 10%, and a tax rate of 40%. Its equity and debt are trading at book value. Using its balance sheet data below, calculate Sharma Builders WACC. Assets Rs. Cash 500 Accounts receivable 300 Inventories 800 Plant and equipment 400 Total Asset 2,000.00 Liabilities and Equity Long-term debt 500 Equity 1,500 Total liabilities and equity 2, 000.00

Solution:
WACC= (E/ V) * Ke + (D/ V) * Kd * (1-Tc) Ke = cost of equity = 15% Kd = cost of debt = 10% E = market value of the firm's equity = Rs.1500.00 D = market value of the firm's debt = Rs.500 V = E + D = Rs. 1500+Rs. 500 = Rs. 2000 E/V = percentage of financing that is equity = 1500/2000 = 0.75 D/V = percentage of financing that is debt = 500/2000 = 0.25 Tc = corporate tax rate = 40% If we put the above value in the formula then we get = 0.75 * 0.15 + 0.25 * 0.10 * (1 - 0.40) = 0.1125 + 0.025 *0.6 = 0.1125 + 0.015 = 0.1275 or 12.75% So the Weighted Average Cost of Capital (WACC) is 12.75%

Why We Calculate WACC ?

A companys assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every rupees it finances.

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