2. The weighted average cost of capital
(WACC) is the rate that a company is expected
to pay on average to all its security holders to
finance its assets.
3. The WACC is the minimum return that a company must
earn on an existing asset base to satisfy its creditors,
owners, and other providers of capital, or they will invest
elsewhere. Companies raise money from a number of
sources: common equity, preferred equity,
straight debt, convertible debt, exchangeable
debt, warrants, options, pension liabilities, executive stock
options, governmental subsidies, and so on. Different
securities, which represent different sources of finance, are
expected to generate different returns. The WACC is
calculated taking into account the relative weights of each
component of the capital structure.
4. WACC = We re + Wp rp + Wd rd (1-tc)
Where,
We is the proportion of equity
Re is the cost of equity
Wp is the proportion of preference
Rp is the cost of preference
Wd is the proportion of debt
Rd is the cost of debt
Tc is the corporate tax rate.
5. A firms after tax cost of capital of the specific source is as follows.
Cost of Debenture - 10%
Cost of Preference Share - 14%
Cost of Equity Share – 16%
The following is the capital of the securities
Debenture Capital Rs.6,00,000
Preference Share Capital Rs.4,00,000
Equity Capital Rs.10,00,000.
Calculate the weighted average cost of capital which is denoted by K0 using
book value weights.
