The document discusses the weighted average cost of capital (WACC), which is used by company management to evaluate capital projects and transactions. WACC serves as a benchmark for investors to assess whether to invest in a project or company. WACC is calculated by multiplying the cost of each capital source (debt and equity) by its relevant weight by market value, and adding the products together. An example calculation is provided to demonstrate how to determine WACC using the common formula that considers market values of equity and debt, costs of equity and debt, and the corporate tax rate.
4. Why it matters?
WACC is used by company management to evaluate
decisions such as capital projects, mergers and
acquisitions, and other large-cost transactions in order
to ensure that their capital structure are within investor
expectations.
It serves as a benchmark for investors on whether to
invest in a project or a company.
5. WACC
calculation
WACC is calculated by multiplying the cost of each
capital source (debt and equity) by its relevant weight
by market value, and then adding the products
together to determine the total.
The method of calculating the WACC can be expressed
in the following formula:
6. WACC formula
WACC =
Where:
E = market value of equity
D = market value of debt
V = E + D
Re = cost of equity
Rd = cost of debt, and
Tc = corporate tax rate
E
V
x Re +
D
V
x Rd x (1- Tc)
Equity
(ownership)
Bonds
(Debt)
7. Example
☛ ₱1,000,000 in capital
☛ 6,000 shares at ₱100
→ 6% return
☛ 400 bonds at ₱1000
→5% return
☛ 25%
Cost of equity is 6%
Cost of debt is 5%
Corporate tax rate
8. .051 = 5.1%
Solutio
n
Equity
(ownership)
Bonds (Debt)
E = 6,000 x 100 = 600,000
D = 400 x 1000 = 400, 000
V = (E+D) = 1,000,000
Re = cost of equity 6%
Rd = cost of debt 5%
Tc = 25%
WACC = 𝟔𝟎𝟎,𝟎𝟎𝟎
𝟏,𝟎𝟎𝟎,𝟎𝟎𝟎
X 6%
𝟒𝟎𝟎,𝟎𝟎𝟎
𝟏,𝟎𝟎𝟎 ,𝟎𝟎𝟎
X 5% X ( 1- 25% )
+
( .6 X .06 )
= .036
( .02 X .75)
= .015
WACC =
Benchmark
Minimum rate of return
Decision- making
