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Weighted Average Cost Of Capital (Wacc)

Ankit0

The weighted average cost of capital (WACC) is a measure of the cost of capital for a company. It is calculated by taking the weighted average of the cost of each type of capital that the company uses.

Formula:

WACC = (E/V)rE + (D/V)rD

where:

  • WACC is the weighted average cost of capital
  • E is the market value of the company’s equity
  • V is the total value of the company’s assets
  • rE is the cost of equity
  • rD is the cost of debt

Steps:

  1. Calculate the weighted average cost of equity (WACC) using the formula above.
  2. Use the weighted average cost of equity to calculate the discount rate for future cash flows.

Assumptions:

  • The company is in equilibrium and is not growing or shrinking.
  • The company is not using any debt.
  • The company has a constant cost of capital.
  • The company will not pay any dividends.

Advantages:

  • WACC provides a single measure of the cost of capital for a company.
  • WACC is used to calculate the present value of future cash flows.
  • WACC is a flexible measure of cost of capital that can be adjusted for different assumptions.

Disadvantages:

  • WACC does not reflect the riskiness of a company’s investments.
  • WACC does not reflect the company’s tax rate.
  • WACC does not reflect the company’s operating leverage.

Disclaimer

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