Weighted Average Cost of Capital - WACC

1. Normally in a business we have capital from equity as well as debt

sources.
2. Equity source means: Ordinary shares or Common stock as well as
preference share for accounting purpose consider as equity, but for
finance purpose consider as debt capital due to the fixation in dividend.
3. Debt source means: Bonds, debentures, overdraft or running finance
facility, means interest bearing source.
4. The generation of profit based on the capital utilization.
5. But we cannot simply add the equity cost of capital and debt cost of
capital to determine the total cost of capital for the company.
6. But we need to calculate the proportionate cost of capital of each source
then we can add them.
7. For example
Equity = 400,000 cost of equity = 15%
Debt Bonds = 150,000 cost of debt = 20%
Overdraft = 100,000 cost of O/D = 10%

Applicable tax rate is 30%

Cost of overdraft after tax adjustment (10% x (1-t))
(10% x (1-0.3)
(10% x 0.7) = 7%
Proportions = Capital source amount / Total capital amount
Total Capital = 400,000 + 150,000 + 100,000 = 650,000
Equity proportion = 400,000 / 650,000 = 0.62
Debt proportion = 150,000 / 650,000 = 0.23
Overdraft proportion = 100,000 / 650,000 = 0.15

WACC = {(cost of equity x Pe) + (cost of debt x Pd) + (cost of o/d x Po/d)}
WACC = {(15x0.62) + (20x0.23) + (7x0.15)}
14.95%
8. WACC percentage always be in between lowest and highest percentage
of all sources of capital.
9. We can do one method to calculate WACC
WACC = {(cost of equity x Value of equity) + (cost of debt x Value of
debt) + (cost of o/d x Value of o/d)}
WACC = {(15x400,000) + (20x150,000) + (7x100,000)}
650,000
14,92%