Computation of Overall Cost Capital WACC Homework Help

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Weighted average cost of capital is a method to calculate the cost of capital of a firm. In WACC, proportional weight is given to each category of capital. It includes various sources of capital like common stock, preferred stock, bonds and other long term debt. As the beta and rate of return on equity increases WACC of a firm also increases an increase in WACC results in a decrease in valuation and an increase in risk. WACC can be determined by multiplying the cost of each component of capital by its proportional weight and adding the results obtained.WACC can be used for determining the value of investments and to choose from alternative sources of investment. It is used to calculate economic value added. The calculation of WACC helps the investors in understanding the WACC and its importance.
WACC can be calculated by using the following formula mentioned in Computation of Overall Cost Capital WACC Homework Help.
 

WACC = E/V*Re+P/V*Rd*(1-Tc)
Where Re= cost of equity
Rd = cost of debt
E market value of the firm’s equity
D= market value of the firms debt
V= E+P= total market value of the firms equity and debt
Tc= rate of corporate tax
 

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Components of formula

 

Components of Formula used for calculating WACC explained in Computation of Overall Cost Capital WACC Homework Help are
 

• Cost of Equity- Calculation of cost of equity can be complex as there is no explicit value for share capital. A company does not know the exact price it has to pay for raising equity. The share holders who invest in the company expect to get certain return from their investment. This required rate of return can be a cost of equity. Thus the cost of equity for a company is the amount it has to incur to keep a share price that will be beneficial for its investors. For more details, students can refer Computation of Overall Cost Capital WACC Homework Help.
 

• Cost of debt Rd- Calculation of cost of debt is a simple process. The market rate currently paid by its company on its debt can be used to calculate the cost of debt.
 

• Tax deductions- In calculating WACC, after tax cost of debt is used as company can avail tax deduction on interest paid by it.
 

There are two components used in calculating WACC given in Computation of Overall Cost Capital WACC Homework Help. They are debt and equity. WACC is the opportunity cost for an investor as investor is taking risk of investing money in a company. As WACC is the overall required return of a firm, the directors of a company can use WACC to make the decisions on the opportunities available for expansion.
 

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