Shaping Futures with Knowledge
The Weighted Average Cost of Capital (WACC) is the average rate of return a company is expected to pay to all its security holders (equity, debt, and preference) to finance its assets. It represents the company's blended cost of capital, considering the proportion and cost of each component.
The formula for WACC is:
WACC = (E/V × Ke) + (D/V × Kd × (1 - T)) + (P/V × Kp)
Where:
Assume the following capital structure:
| Source | Amount (₹) | Cost (%) |
|---|---|---|
| Equity | 5,00,000 | 14% |
| Debt | 3,00,000 | 10% |
| Preference Shares | 2,00,000 | 9% |
| Tax Rate | 30% | |
Total Capital (V) = 5,00,000 + 3,00,000 + 2,00,000 = ₹10,00,000
WACC =
(5,00,000 / 10,00,000 × 14%) + (3,00,000 / 10,00,000 × 10% × (1 - 0.30)) + (2,00,000 / 10,00,000 × 9%)
= 0.5 × 14% + 0.3 × 7% + 0.2 × 9%
= 7% + 2.1% + 1.8% = 10.9%
Interpretation: The company needs to earn at least 10.9% on its investments to satisfy its capital providers and maintain its market value.
The Weighted Average Cost of Capital (WACC) is a crucial financial metric that helps companies evaluate the cost of financing their operations through different sources. A lower WACC indicates cheaper capital, while a higher WACC signifies higher risk and cost of funds. WACC serves as a decision-making tool in investment analysis, project evaluation, and valuation of businesses.
