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required rate of return for security ; and is the market value of all outstanding
securities .
In the case where the company is financed with only equity and debt, the average cost of capital
is computed as follows:
where is the total debt, is the total shareholder's equity, is the cost of debt,
and is the cost of equity. The market values of debt and equity should be used when
computing the weights in the WACC formula.[4]
Contents
1Calculation
o 1.1Tax effects
2Components
o 2.1Debt
o 2.2Equity
3Marginal cost of capital schedule
4See also
5References
6External links
Calculation[edit]
In general, the WACC can be calculated with the following formula:[3]
required rate of return for security ; and is the market value of all outstanding
securities .
In the case where the company is financed with only equity and debt, the average cost of capital
is computed as follows:
where is the total debt, is the total shareholder's equity, is the cost of debt,
and is the cost of equity. The market values of debt and equity should be used when
computing the weights in the WACC formula.[4]
Tax effects[edit]
Tax effects can be incorporated into this formula. For example, the WACC for a company
financed by one type of shares with the total market value of and cost of equity and
one type of bonds with the total market value of and cost of debt , in a country with
This calculation can vary significantly due to the existence of many plausible proxies for each
element. As a result, a fairly wide range of values for the WACC of a given firm in a given year
may appear defensible.[5]
Components[edit]
Debt[edit]
Advantages:
legally obliged to make payments no matter how tight the funds on hand are
in the case of bonds, full face value comes due at one time
taking on more debt = taking on more financial risk (more systematic risk) requiring higher
cash flows
The firm's debt component is stated as kd and since there is a tax benefit from interest payments
then the after tax WACC component is kd(1-T); where T is the tax rate.
Equity[edit]
Advantages:
new equity dilutes current ownership share of profits and voting rights (control)
cost of underwriting equity is much higher than debt
too much equity = target for a leveraged buy-out by another firm
no tax shield, dividends are not tax deductible, and may exhibit double-taxation
3 ways of calculating KKe: