What is the concept of WACC (Weighted Average Cost of Capital) and how is it calculated?

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Answered by suresh

Understanding WACC (Weighted Average Cost of Capital) in Finance

The Concept of WACC (Weighted Average Cost of Capital)

WACC, or Weighted Average Cost of Capital, is a financial metric that calculates the average rate of return a company should earn on all its assets to satisfy its investors. It is a crucial tool in determining the cost of a company's capital.

Calculation of WACC

The WACC formula is calculated by multiplying the cost of each capital source by its proportional weight and summing up the results. The formula is as follows:

WACC = (E/V * Re) + ((D/V * Rd) * (1 - Tc))

  • E: Market value of the company's equity
  • V: Market value of the company's total capital (E + D)
  • Re: Cost of equity
  • D: Market value of the company's debt
  • Rd: Cost of debt
  • Tc: Corporate tax rate

By using this formula, a company can determine the overall cost of capital taking into account both equity and debt financing.

Understanding and effectively utilizing WACC is essential for companies looking to make strategic financial decisions and evaluate potential investments.

Answer for Question: What is the concept of WACC (Weighted Average Cost of Capital) and how is it calculated?