What Is The Cost Of Capital Formula

WACC Formula:

\[ WACC = \left(\frac{E}{V} \times R_e\right) + \left(\frac{D}{V} \times R_d \times (1 - T_c)\right) \]

Market Value of Equity (E):

USD

Total Market Value (V):

USD

Cost of Equity (Re):

Market Value of Debt (D):

USD

Cost of Debt (Rd):

Corporate Tax Rate (Tc):

Weighted Average Cost of Capital (WACC):

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1. What Is The Cost Of Capital Formula?

The Weighted Average Cost of Capital (WACC) represents a company's average after-tax cost of capital from all sources, including common stock, preferred stock, bonds, and other forms of debt. It is the minimum return a company must earn on its existing asset base to satisfy its creditors, owners, and other capital providers.

2. How Does The Calculator Work?

The calculator uses the WACC formula:

\[ WACC = \left(\frac{E}{V} \times R_e\right) + \left(\frac{D}{V} \times R_d \times (1 - T_c)\right) \]

Where:

\( E \) — Market value of equity (USD)
\( V \) — Total market value of equity and debt (USD)
\( R_e \) — Cost of equity (%)
\( D \) — Market value of debt (USD)
\( R_d \) — Cost of debt (%)
\( T_c \) — Corporate tax rate (%)

Explanation: The formula weights the cost of each capital source (equity and debt) by its proportion in the company's capital structure, with debt costs adjusted for tax benefits.

3. Importance Of WACC Calculation

Details: WACC is crucial for investment decisions, capital budgeting, and company valuation. It serves as the discount rate for discounted cash flow analysis and helps determine whether to pursue potential investments.

4. Using The Calculator

Tips: Enter all values in their respective units (USD for monetary values, % for rates). Ensure V = E + D for accurate calculation. Tax rate should be between 0-100%.

5. Frequently Asked Questions (FAQ)

Q1: Why is WACC important for companies?
A: WACC helps companies make informed investment decisions, evaluate project viability, and determine the minimum acceptable return on new investments.

Q2: What is a good WACC value?
A: Lower WACC is generally better, but optimal levels vary by industry. Typically ranges from 5-15% depending on business risk and capital structure.

Q3: How is cost of equity calculated?
A: Often calculated using Capital Asset Pricing Model (CAPM): Re = Rf + β(Rm - Rf), where Rf is risk-free rate, β is beta, and Rm is market return.

Q4: Why adjust debt cost for taxes?
A: Interest expenses are tax-deductible, reducing the actual cost of debt to the company, hence the (1 - Tc) multiplier.

Q5: When should WACC be recalculated?
A: WACC should be reviewed regularly, especially when capital structure changes, interest rates fluctuate, or company risk profile evolves.