The document discusses weighted average cost of capital (WACC). WACC is the average rate of return a company expects to compensate all its investors, calculated as a weighted average of the costs of its various capital components (equity and debt). It provides the basic WACC formula and an example calculation for a corporation raising $1 million in capital through stock and bonds. The WACC matters because it indicates the overall cost of funding projects - the lower the WACC, the cheaper funding will be. The document also lists the WACC for some major soft drink companies and discusses uses of WACC in investment analysis.

1. WACC
BY
INDIRA PRIYADARSINI
HARIKA
SUPRAJA
PALASH

2. What is it??
Weighted average cost of capital (WACC) is the
average rate of return a company expects to compensate
all its different investors.

3. How it works:
Here is the basic formula for weighted average cost of capital:
WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-Tc)]
(Percentage of finance that is equity x Cost of Equity) + (Percentage of finance that is
debt x Cost of Debt) x (1 – Tax Rate)
E = Market value of the company's equity
D = Market value of the company's debt
V = Total Market Value of the company (E + D)
Re = Cost of Equity
Rd = Cost of Debt
Tc= Tax Rate

4. Let us take an example
•Assume newly formed Corporation ABC needs to raise $1 million
in capital so it can buy office buildings and the equipment needed to
conduct its business. The company issues and sells
6,000shares of stock at $100 each to raise the first $600,000. Because
shareholders expect a return of 6% on their investment, the cost of
equity is 6%.
•Corporation ABC then sells 400 bonds for $1,000 each to raise the other
$400,000 in capital. The people who bought those bonds expect a 5%
return, so ABC's cost of debt is 5%.

5. Corporation ABC's total market value is now ($600,000 equity
+ $400,000 debt) = $1 million and its corporate tax rate is 35%.
Now we have all the ingredients to calculate Corporation ABC's
weighted average cost of capital (WACC).
WACC = (($600,000/$1,000,000) x .06) +
[(($400,000/$1,000,000) x .05) * (1-0.35))] = 0.049 = 4.9%
Corporation ABC's weighted average cost of capital is 4.9%.
This means for every $1 Corporation ABC raises from
investors, it must pay its investors almost $0.05 in return.

6. Why it Matters:
•It's important for a company to know its weighted average cost
of capital 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
use of cheaper financing sources.

7. In the above example,
ABC may issue more bonds instead of stock because it can
get the financing more cheaply. Because this would
increase the proportion of debt to equity, and because the
debt is cheaper than the equity, the company's weighted
average cost of capital would decrease.

8. WACC in major soft drink industry:
company equity debt WACC Tax rate
Coco cola 89% 11% 9.32% 0.34
National 83% 17% 8.04% 0.38
PepsiCo 82% 18% 9.27% 0.32
Cadbury 89% 11% 9.32% 0.60

9. Uses of WACC:
•WAAC is used in discounting cash flows for calculation of NPV
and other valuations for investment analysis.
•WACC reflects the risk of the entire company
•WACC is only appropriate to use when the project is of the same
risk as the entire company