Question

The WACC is the weighted average of the costs of the different types of capital (debt and equity) that have been used to finance a company; the cost of each type of capital is weighted by the proportion of the total capital that it represents.(True or False)

Answer 1

The statement is true .

Explanation :-

The WACC is the weighted average cost of capital . The cost of different type of capital used in capital structure (debt, preferred stock and common stock ) are multiplied by their respective proportion in the capital structure and the weighted cost of different sources are added , to calculate the WACC.

For example :-

A capital structure consists of 40% debt and 60% equity . The aftertax cost of debt (Rd) is 8% and cost of equity (Re) is 12% .

So, the wacc is :-

Wd * Rd + We *Re

= (40% * 8%) + ( 60% * 12%)

= 3.2% + 7.2 % = 10.4%

So, the given statement is true.