In: Finance

The Weighted Average Cost of Capital (WAAC) is a centerpiece of financial analysis and planning. Please define WAAC and discuss the three main components of WAAC we covered in class and how the computation of their costs differ. Then provide an explanation as to the uses of WAAC by providing at least two perspectives on its usefulness.

The Weighted Average Cost of Capital (WAAC) is the rate expected by all the stakholders of the company who have financed the business. It is the expected return of total funds including equity, preference and long term debts multiplied with the propotion of each of the funds to the total funds.

WACC is calculated as follows:

WACC = (Cost of Equity Shares * Weight of Equity Shares to total fund) + (Cost of Preference shares* Weight of Preference shares to total fund) + (Cost of Debt * Weight of Debt to total fund)

Thus, as can be seen there are **three broad
components** here in WACC calculations:

**1. Equity Shares**: This represent the common
shareholders who have invested into the company. The cost of equity
is determined by various methods with popular being the
following:

Capital Asset Pricing Model (CAPM), Cost of Equity = Risk Free Rate + (Beta * (Market Return - Risk Free Rate))

Cost of equity under CAPM considers the volatility of the return with respect to the market return expected. Thus, this implies that the cost of equity is influenced by the external market instead by the management of the company.

Dividend Discount / Growth Model, Cost of Equity = (Dividend next year / Price of the share now) + Growth Rate in earnings

Under this method, cost of equity is calculated as a factor of dividends paid on the equity share with relative to the current market price and including the incremental rate due to growth in future earnings.

**2. Preference shares** : This represent another
form of shareholders who have financed the company. The cost of
preference is determined by Dividend next year / Price of the share
now.

**3. Debt :** Debt represents the bonds or any
other long term borrowings. These carry a certain fixed periodic
coupon rates and also a fixed repayment schedule of the debt. The
cost of debt equals the yield expected from the debt when it is
held till maturity. Since the coupon or interest payments on debt
are tax deductible, cost of debt is the after tax yield to
maturity.

Thus, the propotion of financing of each of the above component in a company determines the WACC. For a acceptable WACC, a company has to have a optimum capital structure comprising the three components.

**Uses**:

WACC is a centerpiece of financial analysis and planning.

This is **used by companies to evaluate a future project
or an investment**. This is the minimum rate a project has
to return and thus any project or investment which is expected to
yield a return less than WACC will not be accepted.The calculation
of various capital budgeting techniques like NPV (Net Present
Value) , EVA (Economic Value Added), etc are basis the WACC rate
which is used to discount the future cash flows.

WACC is also used by investors to analyse if the return provided
by the company they have invested equals its WACC. In other words,
WACC is the opportunity cost of capital for the investors. It is
**used by the investors to value a company**. Value of
the firm is determined using the future cash flows expected from
the company discounted by its WACC. The value of the equity is then
determined by deducting the value of debts from the value of firm
and value per equity share is then determined by dividing the value
of equity with equity shares outstanding. Investors make decision
on investments comparing this value per share with the current
market price of the company.

Thus, WACC is a critical measure and companies have to be considerate while choosing their capital structure which needs to be optimal so as to have the minimum possible WACC.

The Weighted Average Cost of Capital (WAAC) is a centerpiece
of financial analysis and planning. Please define WAAC and discuss
the three main components of WAAC we covered in class and how the
computation of their costs differs. Then provide an explanation as
to the uses of WAAC by providing at least two perspectives on its
usefulness.

The weighted average cost of capital is determined by _____ the
weighted average cost of equity.
a. multiplying the weighted average aftertax cost of debt by
b. adding the weighted average pretax cost of debt to
c. adding the weighted average aftertax cost of debt to
d. dividing the weighted average pretax cost of debt by
e. dividing the weighted average aftertax cost of debt by

The weighted average cost of capital (WACC) is calculated as
the weighted average of cost of component capital, including debt,
preferred stock and common equity. In general, debt is less
expensive than equity because it is less risky to the investors.
Some managers may intend to increase the usage of debt, therefore
increase the weight on debt (Wd). Do you think by
increasing the weight on debt (Wd) will reduce the WACC
infinitely? What are the benefits and costs of...

What is Weighted Average Cost of Capital?

Estimating Cost of Equity Capital and Weighted Average Cost of Capital
The December 31, 2015, partial financial statements taken from the annual report for AT&T Inc. (T ) follow.
Consolidated Statements of Income
Dollars in millions except per share amounts
2015
2014
Operating revenues
Service
$ 131,677
$ 118,437
Equipment
15,124
14,010
Total operating revenues
146,801
132,447
Operating expenses
Equipment
19,268
18,946
Broadcast, programming and operations
11,996
4,075
Other cost of services (exclusive of depreciation and...

20. Weighted Average Cost of Capital (WACC) primarily focused
on:
A.definition of “Weighted Average Cost of Capital“ (WACC) and
concept of costs of equity
B.and debt, method of calculation
C.WACC use in corporate financial management
D. factors that affect the cost of equity and debs
E. nature of costs of equity and debt calculation using the
CAPM model
21. Business risks and their typology with focus on:
A.risk classification criteria and their categorization
according to the industry of the enterprise...

Describe the weighted average cost of capital. How do firms use
the weighted average cost of capital for decision making? How are
the costs of debt and equity calculated?
How are the costs of debt and equity calculated?

Suppose that your company’s weighted-average cost of capital is
9 percent. Your company is planning to undertake a project with an
internal rate of return of 12%, but you believe that this project
is not a good investment for the firm. What logical arguments might
you use to convince your boss to forego the project despite its
high rate of return? Is it possible that making investments with
expected returns higher than your company’s cost of capital will
destroy value?...

Charlotte's Crochet Shoppe has 14,300 shares of common stock outstanding at a price per share of $75 and a rate of return of 11.61%. The company also has 280 bonds outstanding, with a par value of $2000 per bond. The pre-tax cost of debt is 6.13% and the bonds sell for 97.2% of the par.
What is the weighted average cost of capital (WACC), if the tax rate is 40%?

In order to calculate an entity weighted average cost of capital
(WACC) financial weight have to be set each component in the firms
capital structure. the weight may be calculated as book or market
value and as historic or target figures.
Explain what is meant by these four types of weights.

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