Model weighted average cost of capital – WACC
Developers of the EVA (Economic Value Added) model Joel Stern and Bennet Stewart suggested using the weighted average cost of capital (WACC) to calculate the EVA indicator. Also, WACC is also used in the program when calculating a modified internal rate of return.
Example of calculating the weighted average cost of capital (WACC)
The model "Weight Average Capital Cost" (WACC) characterizes the average weighted return expected from the total capital invested in the company, both own and borrowed.
WACC is calculated by calculating the weighted cost of the components of the sources of financing using the following formula:
WACC = [Ve / (Ve + Vd)] × ke + [Vd / (Ve + Vd)] × kd × (1 – T)
Where:Ve – the amount of capital of the company;
Vd – the amount of borrowed funds;
kе – coefficient of cost of own capital;
kd – coefficient of cost of borrowed capital;
T – profit tax rate.
Example of calculating the weighted average cost of capital, excluding tax:
| Source of capital | Amount | Weight | Price, % | Cost, % |
| [1] | [2] | [3] | [4] | [5] |
| Preference shares | 35 | 0,1 | 12 | 1,2 |
| Ordinary shares | 105 | 0,3 | 17 | 5,1 |
| Reinvested profit | 140 | 0,4 | 20 | 8 |
| Borrowing sources | 70 | 0,2 | 18 | 3,6 |
| Total: | 350 | 1 | Х | 17,9 |
|
WACC = (35 / 350) * 0,12 + (105 / 350) * 0,17 + (140 / 350) * 0,2 + (70 / 350) * 0,18 = = 0,1 * 0,12 + 0,3 * 0,17 + 0,4 * 0,2 + 0,2 * 0,18 = = 1,2 + 5,1 + 8,0 + 3,6 = 17,9 |
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As can be seen, preferred and ordinary shares are converted into shares in equity (contributed) capital, reinvested earnings - the amount of retained earnings, additional and reserve capital.
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The tax rate, when calculating borrowed sources in the WACC, is not always used in practice, therefore in Budget-Plan Express there is the possibility to "include" or "not include" the rate in the calculation formula: in the settings, under the tab "Investment analysis".
The introduction of interest rates in the Budget-Plan Express settings is mandatory, and not only for the calculation of WACC, but also for its use in other calculations, including the calculation of the complex EVA (Economic Value Added).
In general, if the company is a limited liability company, you can enter the same percentage in the "Preferred, ordinary shares, reinvested profit,%" fields. In this regard, it is useful to recall: the shares in the authorized capital, in the calculations of the program, are equated to ordinary shares.
The percentage (coefficient) of borrowed sources of financing is calculated automatically and for all periods as follows:
R = [ (∑Kn – ∑Zn) / ∑Zn ] х 100%,
r = [ (∑Kn – ∑Zn) / ∑Zn ] = ∑Kn / ∑Zn – 1,
Where:Kn – all payments for n period;
Zn – credit money received for n period;
R – required percentage.
Thus, not only interest-bearing money, but also other payments in the composition of the value of borrowed sources of financing are taken into account.
☛ Model weighted average cost of capital (WACC) is also used in the program when calculating the modified internal rate of return – MIRR.
To change the settings, see «General settings. Investment analysis»
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