17 Questions
What is the purpose of calculating the weight of equity in the weighted average cost of capital?
To determine the proportion of equity in the capital structure
What is the formula to calculate the cost of equity (weighted)?
We x Ke
What is the value of the cost of equity (weighted) if the weight of equity is 40% and the cost of equity is 11%?
4.4%
What is the purpose of multiplying the weight of equity with the cost of equity?
To calculate the weighted average cost of capital
What is the after-tax cost of equity for ORE Consultants?
11%
Why is the after-tax cost of equity the same as the before-tax cost of equity?
Because equity is not a tax-deductible expense
What is the relationship between the weight of equity and the cost of equity in the weighted average cost of capital?
The weight of equity is multiplied by the cost of equity
What is the cost of equity in the given example?
18%
What is the primary purpose of calculating a firm's WACC?
To determine the economic feasibility of expansionary opportunities and mergers
What is the weighted average cost of capital (WACC) in the given example?
12.5%
What is the weighted average cost of capital (WACC) used for?
To determine the economic feasibility of expansionary opportunities and mergers
What is the cost of equity for ORE Consultants?
11%
If the cost of debt is 8% and the corporate tax rate is 35%, what is the after-tax cost of debt?
5.2%
What is the market value of the firm's equity in the given example?
N$400 million
What is the purpose of calculating the cost of capital for a firm?
To determine the economic feasibility of expansionary opportunities and mergers
What is the percentage of financing that is debt in the given example?
60%
What is the formula for the weighted average cost of capital (WACC)?
D/V (Rd) (1-t) + E/V (Re)
Study Notes
Weighted Average Cost of Capital (WACC)
- WACC is the average of the costs of different sources of financing, each weighted by its respective use in the given situation.
- It represents the overall required return on the firm as a whole.
- WACC is used to determine the economic feasibility of expansionary opportunities and mergers.
- It is the appropriate discount rate to use for cash flows with risk similar to that of the overall firm.
Calculating WACC
- Calculate the after-tax cost of debt (Kd) = Before tax cost of debt x (1 – tax rate)
- Calculate the weights of each source of capital (Wd and We) = (Value of debt or equity) / (Total value of debt and equity)
- Calculate the weighted cost of debt (Wd x Kd) and equity (We x Ke)
- WACC = Cost of debt (weighted) + Cost of equity (weighted)
Example Calculations
- ORE Consultants: WACC = 7.14% + 4.4% = 11.54%
- CAPITAL: WACC = (0.60)(0.05)(1- 0.35) + 0.4 (0.10) = 5.95%
- Another company: WACC = 300:7008%(1-35%) + 400:700*18% = 12.5%
The Five C's of Credit
- Character: A customer's willingness to pay
- Capacity: A customer's ability to pay
- Capital: A customer's financial resources
- Conditions: Current economic or business conditions
- Collateral: Security
Test your knowledge on how to calculate the weighted average cost of capital (WACC) using the cost of debt and equity, and understand the impact of corporate tax rate and financing structure. This quiz covers the formula and examples of WACC calculation.
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