Question

1. Whats the WACC？
2. Whatre the components of WACC?
3. Please list those formulas in Q2.
4. How to calculate WACC?
5. Why the weighted average cost of capital (WACC) is used in estimating firm value?

Answer 1

Weighted average cost of the capital as the name suggests is the weighted average of the cost of various sources of capital for a economy.

The components of the WACC are as follows :-

WACC = Wd (Kd(1-t)} +( Wps) (Kps) + (Wce) (Kce)

t = tax rate

Wd = % of debt in the capital structure

Wps = % of preffered stock in the capital structure

Wce = % of common stock in the capital structure

K = cost of various sources of capital

Wacc is used in estimating firm value because =

1. ) It is the opportunity cost of capital for the firm

2.) It reflects the average risk of projects that make up the firm

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