Weighted average capital cost [Reading Notes]

Weighted average cost of capital)

What is weighted average capital cost?

Weighted average capital cost(Weighted average cost of capital, WACC) refers to the weight of an enterprise based on the proportion of all capital of the enterprise, the total cost of capital calculated by weighted average of the capital costs of various long-term funds. Weighted average capital cost can be used to determine the expected rate of return for an average venture capital project.

When using income channels to assess the value of a company, evaluators widely use two methods: equity law and investment capital law (sometimes also called direct law and indirect Law ). The equity method evaluates the value of the company's equity by discounting the company's dividend or equity cash flow. This discount rate should reflect the return rate required by equity investors. The investment capital method focuses on and evaluates the overall value of the company, unlike the equity method, which only evaluates equity. The evaluation result of the investment capital law is the value required by all rights requestors, including creditors and shareholders. At this time, the value of equity must be the sum of the company's overall value minus the value of Creditor's Rights (so it is called an indirect method ). The most common way to obtain company value is to discount the cash flows of all investors in the company, including those of creditors and equity investors, the discount rate is the weighted average capital cost, that is, the weighted average value of equity cost and debt cost. therefore, WACC is an important computing parameter for investment capital value evaluation (direct) or company equity value evaluation (indirect. 

When calculating the proportion of individual funds to all funds, you can calculate the book value, market value, and target value weights respectively.

Market value weights refer to the determination of weights for bonds and stocks at market prices. In this way, the weighted average capital cost can reflect the current situation of enterprises. At the same time, the average price can also be used to make up for the inconvenience caused by frequent changes in the securities market price.

The target value right refers to the determination of the right of a bond or stock based on the expected value of the target market in the future. This kind of capital structure can reflect the expectation, rather than reflecting the past and present capital cost structures just like book value weights and market value weights, therefore, the weighted average capital cost calculated based on the target value weights is more suitable for enterprises to raise new funds. However, it is difficult for enterprises to objectively and reasonably determine the target value of securities, and this calculation method is not easy to promote.

Calculation of weighted average capital cost

The weighted average capital cost is calculated as follows:

 

 

Example:

A company has a total capital of 1 million yuan, of which bonds (W_B ) 0.3 million yuan, preferred shares (W_P ) 0.1 million yuan, common stock (W_S ) 0.4 million RMB, retaining income (W_E ) 0.2 million RMB, the cost of each fund is 6%, 12%, 15.5%, and 15% respectively. Calculate the weighted average capital cost of the enterprise.

1. Calculate the proportion of various funds

2. Calculate the weighted average capital cost

 

 

The basic formula for calculating WACC after tax is as follows:

• WACC: Weighted average capital cost;
• K _E : general equity capital cost of the company;
• K _d : the company's debt capital cost;
• W _E : percentage of equity capital in the capital structure
• W _d : percentage of debt capital in the capital structure
• T: The company's effective income tax rate.

If set:

• Equity Capital Cost: 0.25
• Debt Capital Cost: 0.10
• Proportion of equity in the capital structure: 0.70
• Proportion of liabilities in the capital structure: 0.30
• income tax rate: 0.40

The above data is substituted into the formula, and the result is:

In this case, the cost of all capital in the above example is 19.3%.

 

Transferred from: Think Tank encyclopedia