Weighted average cost of capital , Financial Management

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Posted Date: 2/14/2013 12:36:38 AM | Location : United States





Definition of ''Weighted Average Cost of Capital - WACC''

A calculation of a firm''s cost of capital where each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and another long-term debt - are involved in a WACC calculation. All else equal, the ''Weighted Average Cost Of Capital'' that is abbreviated as WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk.

The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:

WACC = (E/V * Re) + (D/V * Rd) * (1-Tc)


Where:
Re stands for cost of equity
Rd stands for cost of debt
E stands for market value of the firm''s equity
D stands for market value of the firm''s debt
V stands for E + D
E/V stands for percentage of financing that is equity
D/V stands for percentage of financing that is debt
Tc stands for corporate tax rate

Businesses frequently discount cash flows at WACC to determine the Net Present Value (NPV) of a project, using the formula:

NPV = Present Value (PV) of the Cash Flows discounted at WACC.

Posted by isbell | Posted Date: 2/14/2013 12:40:11 AM


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