Weighted Average cost of capital. (Financial Management).

1. 1
[WACC] WEIGHTEDAVERAGECOSTOFCAPITAL

2. COST OF CAPITAL
• It is the opportunity cost of investing the same money in different
investment having similar risk and other characteristics.
• From a financing angle, cost of capital is simply the cost which is
paid for using the capital. Alternatively, a percentage return on
investment that convinces an investor to invest in a particular project
or company is the appropriate cost of capital for that investor.
• Cost of capital is the required return necessary to make a capital
budgeting project, such as building a new factory, worthwhile.

3. Cost of Debt Capital =
Interest Rate * (1 – Tax Rate)
Cost of Equity Capital =
Risk-Free Rate + Beta * (Market Risk
Premium – Risk-Free Rate)
WE CAN CLASSIFY COST OF CAPITAL INTO
FOLLOWING BROAD CLASSIFICATIONS.
1. Cost of Equity Capital. 2. Cost of Debt Capital.

4. • Weighted Average Cost Of Capital (WACC) is a calculation of a
firm's cost of capital in which each category of capital is
proportionately weighted.
• Weighted average cost of capital, as the term itself suggests, is the
weighted average of all types of capital present in the capital
structure of a company.

5. • It's important for a company to know its weighted
average cost ofcapital as a way to gauge the expense of
funding future projects. The lower a company's WACC,
the cheaper it is for a company to fund new projects.
• A company looking to lower its WACC may decide to
increase its useof cheaper financing sources.

6. • To calculate WACC, multiply the cost of each capital component by
its proportional weight and take the sum of the results. The
method for calculating WACC can be expressed in the following
formula:

7. WACC =
Weight of Equity * Cost of
Equity + Weight of Debt * Cost
of Debt.
Or
(E/V*Ke) + (D/V) *Kd*(1-Tax
rate)
• E= Market value of equity.
• V= Total Value of market
equity and debt.
• Ke = Cost of Equity.
• D = Market Value of Debt.
• Kd = Cost of Debt.
• Tax Rate = Corporate Tax
Rate.

8. Solution,
Company A Company B
Kd = 3.25% 4.25%
Ke = 6.17% 2.14%
E = 7,00,000 8,00,000
D = 10,02,220 15,25,520
V = 15,00,500 21,00,420
Tax Rate = 50% 60%
LET’S
TAKE
EXAMPLE Items Company A Company B
Total cost of Debt. 3.25% 4.22%
Total cost of Equity. 6.17% 2.14%
Value of Total Debt. 10,02,220 15,25,520
Value of Total Equity. 7,00,000 8,05,666
Total value of combined debt
and equity.
15,00,500 21,00,420
Income Tax rate. 50% 60%

9. WEIGHTED AVERAGE COST OF CAPITA
= (E/V*KE) + (D/V) *KD*(1-TAX RATE)
7,00,000 10,02,220
15,00,500 15,00,500
x 0.0617 + x 0.0325 + (1 – 0.5) = 0.550 = 55.07%
Company A :
Company B:
8,00,000 15,25,520
21,00,420 21,00,420
x 0.0214 + x 0.0425 + (1 – 0.6) = 0.439 = 43.89%

10. THANK YOU….
“
”
Presented by: Anurag Mathur.
MBA.