Scribd
Upload
6 views3 pages

Understanding Weighted Average Cost of Capital

WACC is the average cost of capital a company incurs from equity and debt, crucial for evaluating investment worthiness. It involves calculating the cost of equity using the CAPM or Dividend Growth Model, and the cost of debt adjusted for tax. WACC is applicable when a project's risk aligns with the company's overall risk, with adjustments for riskier projects requiring a higher discount rate.

Uploaded by

shreya
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
6 views3 pages

Understanding Weighted Average Cost of Capital

WACC is the average cost of capital a company incurs from equity and debt, crucial for evaluating investment worthiness. It involves calculating the cost of equity using the CAPM or Dividend Growth Model, and the cost of debt adjusted for tax. WACC is applicable when a project's risk aligns with the company's overall risk, with adjustments for riskier projects requiring a higher discount rate.

Uploaded by

shreya
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

⚖️Chapter 6: The Weighted Average Cost

of Capital (WACC)

1. What is WACC?
 It is the average cost a company pays for the money it uses — from both equity and
debt.
 Used when deciding if an investment is worth it.

Simple Formula:

2. How to Calculate Cost of Equity?


 CAPM formula:

Cost of Equity= Risk-Free Rate + β × (Market Return − Risk-Free Rate)

Dividend Growth Model:

3. How to Calculate Cost of Debt?


 Based on interest the company pays to borrow money.
 Adjusted for tax because interest saves tax.

4. Risk of Interest Rate Changes


 Duration: How sensitive bond prices are to changes in interest rates.
 Higher duration = More sensitive.
5. Credit Risk
 Credit rating agencies like Moody’s and S&P check how risky a company’s debt is.
 Riskier companies must pay a higher interest rate.

6. When to Use WACC


 Use WACC when a project’s risk is similar to the company’s overall risk.
 If a project is riskier, use a higher discount rate.

You might also like