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WACC Formula

Definition - What does WACC Formula mean?

The weighted average cost of capital (WACC) formula calculates the average return rate that a company needs to earn to compensate its security holders or investors. This calculation is used to measure if a project is profitable or if it just compensates the cost of funding the project.

WACC = (E/V * Re) + [(D/V * Rd) * (1- Tc)]


E = Market value of the company’s equity

V = Total Market Value (E+D)

Re = Cost of Equity

D = Market value of the company’s debt

Rd = Cost of Debt

Tc = Tax Rate

Divestopedia explains WACC Formula

The weighted average cost of capital formula is used to compute whether the funding from different sources, equity and debt, is enough to fund investments such as buying new equipment.

For example, a newly formed company, AB Corporation, plans to buy a big office space and has to raise $1 million to carry out this plan. The company then decides to sell 6,000 of its shares at $100 each to raise $600,000. The cost of equity is 6% as the shareholders of the company now anticipate a return of 6% in the investment.

For the cost of debt, the company now decides to sell 400 bonds for the price of $1,000 each to fill out the remaining $400,000 for its capital. The investors who bought the bonds suppose a 5% return, so that is now the cost of debt.

This now makes AB Corporation’s market value $1,000,000 (equity of $600,000 + debt of $400,000). The corporate tax is 35%.

By plugging in the values for the equation we get the following:

WACC = [(600,000/1,000,000) * 0.06] + {[(400,000/1,000,000) * 0.05] * (1 - 0.350)]} = 0.049 or 4.9%

With a WACC of 4.9%, this implies that AB Corporation needs to pay its investors almost $0.05 for every $1 that it raises.

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