Weighted Average Cost of Capital (WACC) - Practical Example and Issues
Previously, we reviewed the concept of weighted average cost of capital and its formula. This video provides a detailed example of WACC calculation and also discusses some of the issues while using it. The video also discusses in detail the concept of marginal cost and why a firm can't finance itself only from debt even though it looks cheaper.
Estimating the Cost of Capital
Debt: You will notice that the cost of debt is adjusted for tax (1-t) because in most countries the interest on debt is taken as a deduction to arrive at the taxable income. So, what's taken into consideration is the after-tax cost of debt.
Preferred Equity: Estimating the cost of preferred equity is quite straight ward since the dividend is generally stated and fixed.
Common Equity: Estimating the cost of common equity is the most challenging among the three sources of capital. Cost of equity can be estimated using one of the two available methods: 1) using the CAPM model and 2) using the dividend discount model which is based on the discounted cash flows.
Next, we will look at how to determine the weights for each source of capital.
- Weighted Average Cost of Capital (WACC)
- Methods of Calculating Weights in WACC
- Applications of Cost of Capital
- Weighted Average Cost of Capital (WACC) - Practical Example and Issues
- Calculating Cost of Debt: YTM and Debt-Rating Approach
- Issues in Estimating Cost of Debt
- Estimating the Cost of Preferred Stock
- Estimating the Cost of Common Stock
- Calculating Beta Using Market Model Regression (Slope)
- Calculating Beta Using Pure Play Method
- Estimating the Country Risk (Country Equity Premium)
- Marginal Cost of Capital (MCC) Schedule
- Flotation Costs and WACC