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.

Transcript

Hey YouTube, Jimmy here. Once again, we're taking a break from our DOW 30 analysis with a quick investing basics video on WACC or weighted average cost of capital. We're looking at how it's calculated and how can be used effectively weighted average cost of capital is often called WACC for short. Basically, WACC is a way to calculate the cost of ca... Read More

Key Insights

• 🔠 WACC considers the cost of different sources of capital to determine the overall cost of capital for a company.
• 🏋️ The formula for calculating WACC includes percentage weights for debt, preferred shares, and equity.
• ❓ WACC is used to make investment decisions and assess the value of a company's stock.
• 🚕 The tax adjustment in the WACC formula accounts for the tax benefits of debt.
• 🈹 Discounted cash flow and other valuation techniques can utilize WACC as a discount factor.
• 📽️ WACC helps determine if a project will create or destroy wealth for a company.
• ✋ The higher the cost of equity, the higher the WACC will generally be.

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.