Weighted Average Cost Of Capital

Question 1

What does WACC measure?

Answer 1

It can be used to set the discount rate, assuming that the project has the same risk as the existing operations of the firm, hence the firm’s current cost of debt (Kd) and cost of equity (Ke) reflect the appropriate levels of return and therefore it weighs Kd and Ke according to capital structure

Question 2

What is the WACC equation (no taxes)?

Answer 2

WACC=(E/V)Ke+(D/V)Kd
Where:
Ke is the cost of equity
Kd is the cost of debt
E is the market value of equity
D is the market value of debt
V=E+D

Question 3

What is the WACC equation (with taxes)?

Answer 3

WACC=(E/V)Ke+(D/V)Kd(1-t)
Where:
Ke is the cost of equity
Kd is the cost of debt
E is the market value of equity
D is the market value of debt
V=E+D
t is the corporate tax rate

Question 4

How do you calculate the cost of equity (Ke)?

Answer 4

Ke=D/P0+g

Using the dividend model

Question 5

How do you calculate the cost of debt (Kd)?

Answer 5

Using the formula: P0=sum of CFt(1+Kd)^-t

Have to guess the Kd (trial & error)