What is WACC - Weighted Average Cost of Capital | Summary and Q&A

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October 5, 2018
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Learn to Invest - Investors Grow
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What is WACC - Weighted Average Cost of Capital

TL;DR

WACC is a calculation that determines a company's cost of capital by considering the costs of debt, preferred shares, and equity.

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Questions & Answers

Q: What does WACC stand for and what does it calculate?

WACC stands for weighted average cost of capital. It calculates the cost of capital for a company by taking into account the costs of debt, preferred shares (if applicable), and equity.

Q: How is the percentage of debt and equity determined for calculating WACC?

The percentage of debt and equity is determined based on the market value of a company. Divide the amount of debt by the total market value to get the percentage of debt, and subtract this from 100% to get the percentage of equity.

Q: What is the significance of the tax adjustment in the WACC formula?

The tax adjustment is applied to the cost of debt because interest payments are often tax-deductible. By factoring in the tax rate, the cost of debt can be adjusted accordingly.

Q: How can WACC be used as a discount factor in valuation techniques?

WACC can be used to discount expected cash flows, determining their present value. This allows for the evaluation of whether a company's stock is undervalued or overvalued based on its current trading price.

Summary & Key Takeaways

  • WACC, or weighted average cost of capital, is a way to calculate the cost of capital for a company by considering various factors.

  • The formula for calculating WACC may seem complex, but it becomes intuitive once broken down into its components.

  • WACC is used to determine if a company should invest in a project and can also be used as a discount factor in valuation techniques.

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