Question

What is the WACC and how is it calculated?  Are there any other names a company might use for metrics used by the company and based on the WACC?  In what calculations/analyses might a company use the WACC? How are the cost of debt and cost of equity calculated?  Include in your discussion taxes, RATE, and CAPM

Answer 1

Wacc is weighted average cost of capital. Is also called as total cost of capital.

It's the overall cost of raising funds for the firm.

It is used by the company in capital budgeting decisions and capital structure decisions.

WACC CALCULATION:

Part 1:
Cost of Equity:
Capital Asset pricing model:

As per CAPM model:
Ke= Rf+(Rm-Rf)×B

Ke= cost of equity
Rf= Risk-free rate.
Rm-Rf =Market Risk Premium.
B = Beta, systematic risk.

Ke= Rf+(Rm-Rf)×B

Cost of debt=
{{I(1-t)+[(RV-NP)/n]}/[(RV+NP)/2]}

I=coupon amount
t=tax rate
RV = redeemable value/par value
NP = net proceeds/current market value.
n= number of periods.

Cost of preference = preference dividend rate/current selling price.

Part 2:
Total market value= market value of equity+market value of preference share+market value of debt.

=Number of shares outstanding x current share price+number of preference shares outstanding x selling price+ number of debt outstanding x current selling price.

Weight of equity= market value of equity/total market value.

Weight of debt = market value of debt/total market value.

Weight of preference= market value of preference/total market value.

Part 3:

WACC = WEIGHTED AVERAGE COST OF CAPITAL.  

Weighted average cost of capital= (weight of equity x cost of equity)+(weight of debt x cost of debt)+(weight of preference x cost of preference)