Weighted Average Cost of Capital (WACC)

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Definition: Weighted Average Cost of Capital (WACC)

WACC is the cost of capital in which each source of finance or capital is weighed in proportion of the contribution. It takes into consideration sources of capital being preference share, debt, equity and bonds.


Weighted Average Cost of Capital (WACC) = e/v * Re + d/v * Rd*(1-t)

Re = cost of equity
Rd = cost of debt
e = market value of the equity
d = market value of the debt
v = e + d
t = Tax rate

The main use of WACC is in calculating cost of capital for upcoming projects and tasks. WACC is used for :

1) Capital Budgeting

2) Valuation

3) Future Investment Decisions

WACC assumes that the rate would remain same for all future tasks and projects. Also the capital mix is assumed to be same for WACC calculations.

Example :

Firm  A having  60% debt and  40 % equity will have its equity calculated as

Cost of equity =12%

Cost of Debt =10%

Corporate tax =30%

WACC= (0.12*0.4)+(0.1*0.6*0.65) =8.7%

Hence, this concludes the definition of Weighted Average Cost of Capital (WACC) along with its overview.


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