WACC - Weighted Average Cost of Capital

WACC

Calculating WACC - Scenario I

You have been presented with all the variables, and need only to calculate the WACC. This is by far the easiest way to calculate WACC. (Note: The below example doesn't have preferred stocks)

Provided Variables:

Weight of Debt: 60%
Cost of Debt: 10%

Weight of Equity (Common Stock): 40%
Cost of Equity (Common Stock): 18%

Tax Rate: 35%

WACC = Weight of Debt * Cost of Debt (1-Tax Rate) + Weight of Equity * Cost of Equity

= (.6) * (.1)*(1-.35) + (.4) * (.18)
= .111 or 11.1%

So, the Weighted Average Cost of Capital (WACC) in Scenario I was 11.1%

Calculating WACC - Scenario II

Here, you have been provided with Debt-Equity Ratio, Cost of Debt, Cost of Equity, and the Tax Rate. In order to Calculate WACC, you need to find out Weight of Debt and Weight of Equity.

Weight of Debt and Weight of Equity can be found from Debt - Equity Ratio through the formulas

Weight of Debt = (Debt-Equity Ratio) / (1 + Debt-Equity Ratio)

Weight of Equity = 1 / (1 + Debt-Equity Ratio)

Solving the problem:

Listed Variables

Debt-Equity Ratio: .6
Cost of Debt: 10%
Cost of Equity 18%
Tax Rate: 35%

WACC = ?

Step 1: Calculate Weight of Debt and Weight of Equity

Weight of Debt = Debt-Equity Ratio / (1 + Debt-Equity Ratio) = .6/ (1+.6)
Weight of Debt = .375 or 37.5%

Weight of Equity = 1 / (1 + Debt-Equity Ratio) = 1 / (1 + .6)
Weight of Equity =.625 or 62.5%

Step 2: Calculate WACC

WACC = Weight of Debt * Cost of Debt (1-Tax Rate) + Weight of Equity * Cost of Equity
WACC = (.375) * .1(1-.35) + (.625) * (.18)
WACC = .136875
WACC = 13.69%

In the above example we got Weighted Average Cost of Capital as 13.69%

Calculating WACC - Scenario III Preferred Stocks

In Scenario 3, you have been presented with all variables, but this time around, the WACC calculation includes Preferred Stocks.

Listed Variables:

Tax Rate : 40%
Cost of Common Stock: 13.9%
Cost of Preferred Stocks: 5.8%
Cost of Debt: 6.40%
Weight of Common Stock: 63.93%
Weight of Preferred Stock: 6.61%
Weight of Debt: 29.46%

WACC = Weight of Debt * Cost of Debt (1-Tax Rate) + Weight of Common Stocks * Cost of Equity + Weight of Preferred Stocks * Cost of Preferred Stocks

WACC = 29.46% * 6.40% (1-40%) + 63.93% * 13.9% + 6.61% * 5.8%

WACC = 10.40%

All the 3 listed above examples are very basic calculations for WACC. I will list more complex examples of WACC Calculations in the near future.

Also, in the above examples we assumed that we knew how to calculate or were given the Cost of Equity, Cost of Debt, Cost of Preferred Stocks, and as such. In later sections, I will also explain how to find Cost of Equity, Cost of debt, Cost of Preferred Stocks, Weight of Common Stocks, Weight of Bonds, and Weight of Debt.