Question

WACC should be calculated based on:

Answer 1

WACC or the Weighted Average Cost of Capital uses the market value of debt and equity. Capital is the most essential item for any business. A business cannot function without capital. It has to procure capital from various sources such as from the shareholders by issuing shares of company or by taking loans and advances from banks or financial institution. There is a cost associated with such procurement. For example banks and financial institutions charge interest against the loans and advances. This becomes the cost of debt. To get the debt from banks we need to pay interest to them. Similarly equity shareholders are paid dividend by the company for the investment in shares made by them.

The Weighted Average Cost of Capital or the cost of capital is calculated using the formula

Cost of Equity * Weight allocated to equity + Cost of debt * Weight allocated to debt* (1-Tax rate)

These weights are based on the market values.