In: Finance
Do we need to know the cost of equity to calculate the WACC?
answer :-
yes we need to know the cost of equity to calculate the weighted average cost of capital(WACC ).
explanations :
first we see the definition of WACC:- WACC is the cost of capital of the entity, in which each category of capital is proportionatly weighted , all sources of capital including equity stock, preffered stock, bonds, and any other long term debt are included in WACC calculation.
formula of WACC calulation : E/V*Re +D/V*Rd*(1-Tc)
here:
Re = cost of equity
Rd= cost of debt
E = market value of entity equty
D= market value of entity debt
V=E+D=Total market value of the entity financing
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc= corporate tax
since from the definition and formula we can understand that cost of equity need to know to calculate the cost of capital.
senario 1 :suppose a entity is having only equity stock in its capital structure , WACC of that entity is equals to the cost of quity
senarios 2 : suppose a entity is having quity and debt in its capital structure , WACC is average of cost of equity and cost of debt( after tax for debt only )
so form the above discussion we can understand that cost of capital is the one of the main component in calculation of WACC, so we need to know the cost of equity in the calculation of WACC