This weighted average cost of capital calculator, or WACC calculator for short, lets you find out how profitable your company needs to be in order to generate value. With the use of the WACC formula, calculating the cost of capital will be nothing but a piece of cake.
If you already know how to calculate WACC, be sure to take a look at its real-life application in the discounted cash flow valuation.
What is WACC?
If you are an entrepreneur, one of your primary objectives is to increase your company's value. To do that, you often need a lot of startup capital to make necessary purchases or get your business off the ground.
There are many potential sources of capital: common and preferred stocks, bonds, or debts. They are generally divided into two categories: equity, which is the total value of all assets, and debt, which is the money you borrowed.
The capital gained through equity or debts comes at a certain cost. The cost of debt is pretty straightforward - you always have to give back more money than you borrowed. The proportion between borrowed and returned capital is expressed with an interest rate. For example, if the interest rate is 8%, you have to return $108 for every $100 you borrowed.
In the case of the cost of equity, the calculations are not so straightforward. Generally, it is assumed that the cost of equity is all the expenses you need to bear to convince your stakeholders that your company is worth investing in. If your stakeholders don't feel they are receiving reasonable compensation for the risk they are taking, they will likely sell their shares, which will decrease your company's value.
If your company gained financing from both equity and debt, then you need to combine the cost of debt and the cost of equity in one metric to determine whether it will be profitable enough. This metric is called WACC - the weighted average cost of capital.
If your company's rate of return is higher than the WACC, it is profitable. If the rate of return is lower, your financing costs are not covered, which usually means you're in deep trouble.
If you want to calculate the WACC for your company, you need to use the following WACC formula:
WACC = E / (E + D) * Ce + D / (E + D) * Cd * (100% - T)
- WACC stands for the weighted average cost of capital, expressed as a percentage;
- E is the equity,
- D is the debt,
- Ce is the cost of equity,
- Cd is the cost of debt, and
- T is the corporate tax rate.
The corporate tax rate takes into account the tax deduction on interest paid.
How to calculate WACC?
If you're still unsure whether you understand the concept of the weighted average cost of capital, take a look at the example below. It explains how to calculate WACC for a small company in detail.
Determine how much of your capital comes from equity. For example, you have $700,000 in assets.
Write down your debts - for instance, you might have taken a loan of $500,000.
Estimate the cost of equity. Let's assume it is equal to 15%.
Check the cost of debt, too. For example, the interest rate on your loan might be equal to 8%.
Decide on what is the corporate tax rate. We will assume it is 20%.
Substitute all these values into the WACC formula:
WACC = E / (E + D) × Ce + D / (E + D) × Cd × (100% - T)
WACC = $700,000 / ($700,000 + $500,000) × 15% + $500,000 / ($700,000 + $500,000) × 8% × (100% - 20%)
WACC = 0.583 × 0.15 + 0.417 × 0.08 × 0.8
WACC = 0.0875 + 0.0267
WACC = 11.42%
This value of WACC can be used in further calculations as the cost of capital. For example, you can apply it in our Net Present Value calculator.