weighted average cost of capital

Examples of weighted average cost of capital in the following topics:

• Weighted Average Cost of Capital

  • The weighted average cost of capital (WACC) is a calculation that reflects how much an organization pays in interest when acquiring financing options.
  • From debt options such as taking out loans or offering long-term corporate bonds to equity such as preferred and common stock, larger organizations tend to find a balance between these options that is optimized for the best possible weighted average cost of capital (WACC) to operate at the scale that creates the best revenue opportunity.
  • In short, the WACC is a measure of what all of these capital inputs will cost the organization in terms of an average interest rate.
  • Calculating the cost of capital is actually quite a simple equation.
  • This diagram is an excellent illustration of how various forms of debt and equity consolidate into broader calculation of debt and equity overall, and how those can combine as a total weighted average cost of capital.

• Factors External to the Firm

  • The weighted average cost of capital is vulnerable to market risks, interest rate changes, inflation, economic factors, and tax rates.
  • When organizations begin weighing the weighted average cost of capital (WACC) and determining overall capital structure, there are some factors that are within the control of the organization, and some external factors that are not.
  • Profit beyond the cost of expenses and capital will be taxed as well, which impacts the overall weighted average cost of capital.
  • Any external factors in the form of opportunity costs or unexpected risks can impact the overall cost of capital.
  • Recognize the various external factors that may impact the weighted average cost of capital

• The Weightings

  • To calculate the weighted average cost of capital (WACC) we must take into account the weight of each component of a company's capital structure.
  • If the value of a company's debt exceeds the value of its equity, the cost of its debt will have more "weight" in calculating its total cost of capital than the cost of equity.
  • If the value of the company's equity exceeds its debt, the cost of its equity will have more weight.
  • Since we are measuring expected cost of new capital, the calculation of weighted average cost of capital usually uses the market values of the various components rather than their book values.
  • Define how a company's weighted average cost of capital is weighted

• Differences Between Required Return and the Cost of Capital

  • The average cost of capital is calculated via combining the overall average required rate on debt stakeholders and equity stakeholders
  • This required amount of return will ultimately equal the cost of capital, as the required rate from the investor is now a cost being put on the borrower.
  • Now, cost of capital for a given investor will always equate to the required return.
  • This is where the concept of weighted average cost of capital (WACC) enters the equation, as there may be more than one investor with varying rates of return.
  • Calculate the weighted average cost of capital by understanding the required rate of various investors

• Cost of Capital Considerations

  • One of the major considerations that overseers of firms must take into account when planning out capital structure is the cost of capital.
  • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
  • A company's securities typically include both debt and equity, so one must therefore calculate both the cost of debt and the cost of equity to determine a company's cost of capital.
  • The weighted average cost of capital multiplies the cost of each security by the percentage of total capital taken up by the particular security, and then adds up the results from each security involved in the total capital of the company.
  • Describe the influence of a company's cost of capital on its capital structure and investment decisions

• Cost of capital

  • The cost of capital refers to the cost of the money used to pay for the capital.
  • Moreover, if a project contains a similar risk to a company's average business activities, then it is reasonable to use the company's average cost of capital as a basis for evaluating the success of investment .
  • In order to determine a company's cost of capital, the cost of debt and the cost of equity must be calculated.
  • One way of combining the cost of debt and equity to generate a single cost of capital number is through the weighted-average cost of capital (WACC).
  • The cost of capital is the cost of the money used to finance the plant.

• The Cost of New Common Stock

  • When it comes to the cost of capital, common stock is one of a few options on the table for raising funding.
  • In order to understand the weighted average cost of capital (WACC) of all of these inputs, the cost of each source of debt and/or equity must be determined.
  • In terms of literal capital spent, the issuance of new common stock incurs a variety of capital costs both at the initial offering and throughout the process of managing this funding source over time:
  • In addition to the tangible capital costs involved, there are also a variety of indirect trade-offs that organizations must understand prior to pursuing this source of funding.
  • Weigh the direct and indirect costs of issuing new common stock as a form of capital

• Optimal Capital Structure Considerations

  • One of the major considerations that overseers of firms must take into account when planning out capital structure is the cost of capital.
  • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
  • A company's securities typically include both debt and equity; therefore, one must calculate both the cost of debt and the cost of equity to determine a company's cost of capital.
  • The weighted average cost of capital multiplies the cost of each security by the percentage of total capital taken up by the particular security, and then adds up the results from each security involved in the total capital of the company.
  • Explain the influence of a company's cost of capital on its capital structure and therefore its value

• The Marginal Cost of Capital

  • The marginal cost of capital is the cost needed to raise the last dollar of capital, and usually this amount increases with total capital.
  • The marginal cost of capital is calculated as being the cost of the last dollar of capital raised.
  • This happens due to the fact that marginal cost of capital generally is the weighted average of the cost of raising the last dollar of capital.
  • Since the cost of issuing extra equity seems to be higher than other costs of financing, we see an increase in marginal cost of capital as the amounts of capital raised grow higher.
  • The Marginal Cost of Capital is the cost of the last dollar of capital raised.

• Average Cost Method

  • Note that we compute weighted average cost per unit by dividing the cost of units available for sale, $690, by the total number of units available for sale, 80.
  • There are two commonly used average cost methods: Simple Weighted Average Cost method and Moving-Average Cost method.
  • The following is an example of the weighted average cost method:
  • The Weighted-Average Method of inventory costing is a means of costing ending inventory using a weighted-average unit cost.
  • Weighted-average costing takes a middle-of-the-road approach.