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Definition – What is weighted average cost of capital?
WACC is the cost of a firm’s capital where each category is proportionally weighted.
Formula – How to calculate WACC
WACC = ((Market Value of Equity / (Market Value of Equity + Market Value of Debt)) x Cost of Equity) + ((Market Value of Debt / (Market Value of Equity + Market Value of Debt) x Cost of Debt x (1 – Tax Rate))
Convert all percentages to a decimal (divide by 100%). Convert the final result back to a percentage (multiply by 100%).
Example
A firm has a cost of equity of 5.5%, cost of debt of 6.5%, market value of equity of $50,000, and market value of debt of $45,000. The corporate tax rate is 25%.
WACC = (($50,000 / ($50,000 + $45,000)) x 0.055) + (($45,000 / ($50,000 + $45,000) x 0.065 x (1 – 0.25))
WACC = (($50,000 / $95,000) x 0.055) + (($45,000 / $95,000) x 0.065 x 0.75))
WACC = (0.5263 x 0.055) + (0.4737 x 0.065 x 0.75)
WACC = 0.0289 + 0.0231
WACC = 0.052, or 5.2%
Therefore WACC in this firm is 5.2%.
Sources and more resources
- Wikipedia – Weighted Average Cost of Capital – An overview of how WACC is calculated.
- The Balance SMB – Calculate Weighted Average Cost of Capital – A discussion on weighted average cost of capital and its calculation.
- Investopedia – Weighted Average Cost of Capital – A break down of WACC.