# Weighted average cost of capital: Wikis

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# Encyclopedia

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets.

The WACC is the minimum return that a company must earn on existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Companies raise money from a number of sources: common equity, preferred equity, straight debt, convertible debt, exchangeable debt, warrants, options, pension liabilities, executive stock options, governmental subsidies, and so on. Different securities are expected to generate different returns. The WACC is calculated taking into account the relative weights of each component of the capital structure and is used to see if the investment is worthwhile to undertake[1].

The more complex the company's capital structure, the more laborious it is to calculate the WACC.

## General formula

In general, the WACC can be calculated with the formula[2]:

$\text{WACC} = \sum_{i=1}^N \left(r_i\cdot \frac{MV_i} {\sum_{j=1}^N MV_j}\right)$, where N is the number sources of capital (securities, types of liabilities); ri is the required rate of return for security i; MVi is the market value of all outstanding securities i.

## The formula for a simple case

In a simple case where the company is financed by homogeneous equity and debt, the weighted average cost of capital can be found through:

$\text{WACC} = \left({E \over {D + E}}\right) \cdot y + \left( {D \over {D + E}} \right) \cdot d \left(1-t_C\right)$, where $\ y = t_R + t_P \cdot B$, where:

Symbol Meaning Units
$\ y \$ required or expected rate of return on equity, or cost of equity  %
$\ d$ required or expected rate of return on borrowings before taxes  %
$\ t_R$ risk free rate  %
$\ t_P$ risk premium rate  %
$\ B$ Beta coefficient -
$\ t_C$ corporate tax rate  %
$\ D$ total debt and leases (including current portion of long-term debt and notes payable) currency
$\ E$ total market value of equity and equity equivalents or market cap (number of shares outstanding X share price) currency
$\ K$ total capital invested in the going concern currency

## References

1. ^ G. Bennet Stewart III (1991). The Quest for Value. HarperCollins.
2. ^ J. Miles und J. Ezzell. "The weighted average cost of capital, perfect capital markets and project life: a clarification." Journal of Financial and Quantitative Analysis, 15 (1980), S. 719-730.