Question

Explain the weighted average cost of capital (WACC) calculation. What is its significance in valuation analysis? What are the components of the calculation? What does each represent?

Answer 1

WACC = Weighted Avg cost of sources in capital structure.

Generally it is used to evaluate the projects which are financed by mutiple sources such as Equity, Debt. and Preferred shares etc.

As the Project is financed by multiple sources, we need to consider the weighted rate for evaluation.

WACC = [ We* Ke ] + [ Wd * (Kd (1 - Tax ) ] + [ Wp * Kp ]

We = Weight of Equity

Wd = Weight of Debt

Wp = Weight of Preferred stock

Ke = Cost of Equity

Kd (1 - Tax Rate ) = After Tax cost of debt

Kp = Cost of preferred stock

Pls do rate, if the answer is correct and comment, if any further assistance is required.