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Peer Post: Weighted average cost of capital (WACC) represents a firm’s average after-tax cost of capital from all sources, including common stock, preferred stock, bonds, and other forms of debt. WACC is the average rate that a company expects to pay to finance its assets.WACC is a common way to determine the required rate of return because it expresses, in a single number, the return that both bondholders and shareholders demand to provide the company with capital. A firm’s WACC is likely to be higher if its stock is relatively volatile or if its debt is seen as risky because investors will require greater returns. The company can control weather it decides to take on more projects or choose not to.
When valuing common stock equity, there are two common models or techniques that can be used. The first is the constant-growth valuation model, also known as the Gordon Model. This model assumes that dividends will grow at a constant rate in perpetuity. In order to calculate the value using this model, we need to know the current dividend per share, the expected dividend growth rate, and the required rate of return. The second common model for valuing common stock equity is the capital asset pricing model (CAPM). This model takes into account the risk of the investment and requires estimates of both the expected return and the risk-free rate.
In order to calculate debt, first, calculate the total interest expense for the year. If your business produces financial statements, you can usually find this figure on your income statement. (If you compile these quarterly, add up total interest payments for all four quarters. Total up all of your debts. You can usually find these under the liabilities section of your company’s balance sheet. Then, divide the first figure (total interest) by the second (total debt) to get your cost of debt.
Hargrave, M. (2022, November 3). Weighted average cost of capital (WACC) explained with formula and example. Investopedia. Retrieved December 1, 2022, from https://www.investopedia.com/terms/w/wacc.asp
Kk. (2022, August 2). Cost of common stock: Formula. Accountinguide. Retrieved December 1, 2022, from https://accountinguide.com/cost-of-common-stock/
Hayes, A. (2022, September 26). Cost of debt: What it means, with formulas to calculate it. Investopedia. Retrieved December 1, 2022, from https://www.investopedia.com/terms/c/costofdebt.asp
