Question

List and explain all the components of the WACC equation.

Question 17 List and explain all the components of the WACC equation. Arial3 (12pt) RE Path: p

Answer 1

The weighted average cost of capital is calculated using the below formula:

WACC=Wd*Kd(1-t)+Wps*Kps+We*Ke

where:

Wd= Percentage of debt in the capital structure.

Kd= Before tax cost of debt

Wps= Percentage of preferred stock in the capital structure

Kps=Cost of preferred stock

We=Percentage of equity in the capital structure

Ke= cost of common equity.

T= Tax rate

Cost of debt

The after tax cost of debt is calculated as Kd(1-t).

Cost of preferred stock

Cost of preferred stock is calculated using the below formula:

Kps=Dps/P

where:

Kps= Cost of preferred stock

Dps=preferred dividend

P= Market price of preferred stock

Cost of Equity

Cost of equity is calculated using the Capital Asset Pricing Model (CAPM).

It is calculated using the below formula

Ke=Rf+$\beta$[E(Rm)-Rf]

where:

Rf=risk-free rate of return which is the yield on default free debt like treasury notes

Rm=expected rate of return on the market.

$\beta$= Beta of the company

In case of any query, kindly comment on the solution.