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    WACC

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    Devansh Verma
    The weighted average cost of capital (WACC) is used to evaluate whether a company should undertake a capital project. It is the average rate of return a company must provide to its investors to compensate for the risk of its operations. The WACC is calculated as a weighted average of the cost of the company's debt and equity. The cost of equity is determined using models like CAPM and represents the return required by shareholders. The cost of debt is the interest rate a company pays on its borrowings and is impacted by its credit risk and tax benefits from interest payments.

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    WACC

    Uploaded by

    Devansh Verma
    13 views2 pages
    The weighted average cost of capital (WACC) is used to evaluate whether a company should undertake a capital project. It is the average rate of return a company must provide to its investors to compensate for the risk of its operations. The WACC is calculated as a weighted average of the cost of the company's debt and equity. The cost of equity is determined using models like CAPM and represents the return required by shareholders. The cost of debt is the interest rate a company pays on its borrowings and is impacted by its credit risk and tax benefits from interest payments.

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    The weighted average cost of capital (WACC) is used to evaluate whether a company should undertake a capital project. It is the average rate of return a company must provide to its investors to compensate for the risk of its operations. The WACC is calculated as a weighted average of the cost of the company's debt and equity. The cost of equity is determined using models like CAPM and represents the return required by shareholders. The cost of debt is the interest rate a company pays on its borrowings and is impacted by its credit risk and tax benefits from interest payments.

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    13 views2 pages

    WACC

    Uploaded by

    Devansh Verma
    The weighted average cost of capital (WACC) is used to evaluate whether a company should undertake a capital project. It is the average rate of return a company must provide to its investors to compensate for the risk of its operations. The WACC is calculated as a weighted average of the cost of the company's debt and equity. The cost of equity is determined using models like CAPM and represents the return required by shareholders. The cost of debt is the interest rate a company pays on its borrowings and is impacted by its credit risk and tax benefits from interest payments.

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    Understanding WACC

    The weighted average cost of capital it the average cost of capital


    for the company to decide whether it should take a capital
    budgeting project. It is the required rate of return that the
    company must provide to its shareholders, bondholders,
    preferred equity holders, etc. It is a single number that expresses
    the return that the bondholders and equity holders demand to
    provide the company with capital.

    Components of WACC
    The WACC comprises of the weighted average of debt and equity
    multiplied with their respective rates of return.

    Cost of equity
    Cost of equity is the required rate of return that a company must
    provide to its shareholders for investing in the company's equity,
    which is obviously risky because of the stock's volatility. The market
    demands compensation for ownership in the risky assets of the
    company.
    Another perspective of looking at it would be with respect to capital
    budgeting projects, wherein it becomes the rate of return required
    by the company to earn break even. The cost of equity is calculated
    by the CAPM model.
    Cost of debt
    The cost of debt is a straightforward number, indicating the
    effective rate of interest a company pays on its debt obligations
    such as bond and loans. Capital structure deals with how a firm
    finances its overall operations and growth through different
    sources of funds, which may include debt such as bonds or
    loans.
    A company could determine it's pre tax cost of debt by
    calculating the overall rate of interest it pays on its various debt
    obligations. This formula is also inclusive of the risk free rate of
    return and the credit spread, lenders usually take everything
    into consideration while calculating the rate of interest. The
    credit risk spread is composed of the company risk premium
    and the country risk premium both of which can be derived
    from the ratings for the company's bonds and the ratings of the
    government securities.

    Post tax cost of debt


    Tax codes favor the interest payments on debt obligations of a
    company. This interest is deducted from the net taxable income
    and thus reduces the tax paid by the company. This in turn
    reduces the cost of debt paid by the company.
    Several factors can increase the cost of debt, depending on the
    level of risk to the lender. These include a longer payback
    period, since the longer a loan is outstanding, the greater the
    effects of the time value of money and opportunity costs. The
    riskier the borrower is, the greater the cost of debt since there is
    a higher chance that the debt will default and the lender will not
    be repaid in full or in part.

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