Weighted Average Cost of Capital

Running Head: Financial Management
[Type the company name]
Financial Management

Financial Management
Contents
2. Weighted Average Cost of Capital....................................................................................................2
2.1 Variables included in the WACC.................................................................................................2
2.2 Results and analysis.....................................................................................................................4
References.............................................................................................................................................6
Appendix...............................................................................................................................................7
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Financial Management
2. Weighted Average Cost of Capital
Weighted average cost of capital shows the cost of capital of the firm which is a mixture of
all the sources of funds like shares, preference shares, debentures etc. Every capital is
weighed by its percentage of total amount of capital in order to find the cost of each capital
type. After this all the costs are added. WACC is mainly used by the investors for identifying
the alternative opportunities for investment (Research Repository, N.D.).
Formula to compute WACC
WACC = (E/V) (Re) + (D/V) (Rd) (1-Tc)
where:
(E/V) = Percentage of common equity in capital structure
(D/V) = Percentage of debt in capital structure
(Re) = Firm’s cost of equity
(Rd) = Firm’s cost of debt
(Tc) = Firm’s corporate tax rate
2.1 Variables included in the WACC
Every company has two sources of funds in order to finance its assets, the one is Equity and
the other is debt. The organizations who wish to have control over the assets of the company
they usually go for debt financing. However, in case of debt financing the company is
required to bear more interest rates as compared to what they bear on equity financing. So the
companies who resist in taking borrowing risk they usually prefer equity financing.
Cost of equity (Re) is the amount a company is required to bear in order to satisfy the
investors. The companies need to evaluate the inputs like firm specific parameters and market
based parameters to calculate an acceptable cost of equity (Queensland Competition
Authority, 2019).
Cost of debt (Rd) is the effective rate of interest that an organisation needs to pay to its
creditors and debt holders.
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