How do I calculate WACC?
Determine the Components of Capital: Identify the different sources of capital that a company uses to finance its operations. These typically include equity, debt, and sometimes preferred stock.
1. Calculate the Cost of Equity (Re): The cost of equity represents the return that shareholders expect from investing in the company’s stock. It can be calculated using various methods, such as the Capital Asset Pricing Model (CAPM), Dividend Discount Model (DDM), or Gordon Growth Model (GGM).
2. Calculate the Cost of Debt (Rd): The cost of debt is the interest rate the company pays on its debt obligations, such as bonds or loans. It can be either the current interest rate the company is paying on its debt or an estimate based on the company’s credit rating and market conditions.
3. Determine the Weight of Each Component: Determine the proportion of each component (equity, debt, preferred stock) in the company’s capital structure. This is usually based on the market value or book value of each component.
4. Calculate the Weighted Average Cost of Capital (WACC): Use the following formula to calculate the WACC,
[Tex]WACC=(\frac{E}{V}\times{r_e})+(\frac{D}{V}\times{r_d}\times{(1-T_c)})+(\frac{P}{V}\times{r_p})[/Tex]