WEIGHTED AVERAGE COST OF CAPITAL

Weighted Average Cost of Capital Worksheet

There exist two primary types of financing - debt and equity.  Each of these has its own unique benefits and disadvantages.  In theory, the ideal mix of these two types of financing is that which minimizes the weighted average cost of capital (WACC).  A WACC analysis takes into account the amount and cost of the different sources of financing used by the firm.  The result is a hurdle rate for all potential projects.

BENEFITS OF A WACC ANALYSIS

Knowing its hurdle rate helps the firm identify projects that will add value.  Additionally, it also demonstrates the effects of various sources of financing.

THE WACC PROCESS

• Collect information about all current sources of financing
• Input and calculate the after-tax costs of these various sources
• Calculate the firms WACC
• Ascertain if additional financing would be beneficial
• Provide support on the most appropriate means of obtaining additional financing, if needed

FURTHER READING

These links elaborate on the topic at hand.  They serve as a good starting point for those companies that would like to learn more or would like to address these topics “in house.”  For those firms that prefer to continue to focus on their current responsibilities and would value the objective viewpoint of a professional from outside of the organization, click here. 

The University of Maine – Cooperative Extension Publications – Bulletin #3008
Excerpt:  “Different types of small businesses require different amounts and types of capital to get started. In some cases, the new businesses may only need capital for short periods of time for inventory purchases or salaries."

Mechanics of Discounted Cash Flow Valuation – WACC | Financial Modeling Guide
Excerpt:  “One of the most important aspects of financial theory in financial modeling and valuation is the weighted average cost of capital (WACC). The WACC is the discount rate, or time value of money, used to convert expected future cash flow into present value.”

ImperoCo Business Solutions - "Developing Organizational Success."