What is WACC?

WACC is the average after-tax cost of company’s various capital sources, including
common stock, preferred stock, bonds, and any other words, WACC is the average rate
a company expects to pay to finance its assets.

Since a company’s financing is largely classified into two types (debt & equity), WACC
is the average cost of raising that money, which is calculated in proportion to each of the
sources.

Formula: WACC= (E/V x Re) + (D/V x Rd x (1-Tc))

E= Market value of the firms’s equity

D= Market value of the firms’s debt

V= E + D

Re= Cost of equity

Rd= Cost of debt

Tc= Corporate tax rate

Relation between Equity and Debt components of WACC:

It is common misconception that equity capital has no concrete cost that the company
must pay after it has listed its shares on the exchange. In reality, there is a cost of
equity.

The shareholders’ expected rate of return is considered a cost from the company’s
perspective. That is because if the company fails to deliver this expected return,
shareholders will simply sell off their shares, which will lead to decrease in share price
and the company’s overall valuation. The cost of equity is essentially the amount that a
company must spend in order to maintain a share price that will keep its investors
satisfied and invested.

The debt-linked component in the WACC formula, (D/V x Rd x (1-Tc)), represents

the cost of capital for company-issued debt. It accounts for interest a
company pays on the issued bonds or commercial loans taken from bank.
Here, I will pass over my friend to present the example of how to use
WACC.