The weighted average cost of capital WACC is known to be a financial metric that lets you find out the cost of a firm in combination with the cost of debt and cost of equity structure collectively. It simply means that you will get the MIN rate of return that a firm requires to produce for handling the lenders as well as shareholders. In a nutshell, WACC is also known as the simple cost of capital.
Syntax of WACC:
Let’s have a look at the formula used for calculating the WACC in Excel and for this you may use multiple formulas as well as functions. Below is the WACC formula:
WACC=(We x Ke) + (Wd x Kd)
Below is the explanation of arguments used in the formula given above:
We – Working equity that shows Total Equity
Ke – Cost of equity
Wd – Value of debt that includes Long term debt
Kd – Cost of Debt
All these arguments are needed one by one to calculate the WACC in Excel.
WACC Components:
You will find four different components used in WACC. All of them are necessary and you cannot skip any of them.
- Market Valuation of Equity
- Cost of Debt
- Market Valuation of Debt
- Cost of Equity
Market Valuation of Equity:
A particular company’s shares come up in terms of the summation of the price in the market value of the Equity.
Cost of Debt:
The cost of debt shows the amount that a company has to pay for the debt it holds in terms of loans and bonds.
For a company, the cost of debt is considered a vital indicator of risk factors. The cost of debt appears to be higher in riskier companies.
For this, the below-given formula is used:
Cost of Debt = Interest rate x (1 – Tax rate)
Market Valuation of Debt:
Most of the time the debt value remains hidden that’s why making a correct estimation of the Debt is always tiring.
Cost of Equity:
The cost of Equity simply shows the return rate of shares a company holds by the shareholder. No amount is paid at the time of share issuance. The shareholders buy these shares on their own.
When a company faces troubles, the stock prices also get disturbed. However, the shareholders tend to demand a fixed amount in return for buying the shares. And the company is accountable for this return amount.
The cost of equity is the amount that the company has to pay in the long run to produce the investment. Below you can find the formula used for the cost of Equity.
Cost of Equity = Risk Free Rate + Beta * (Market Return Rate – Risk Free Rate)
Calculating WACC in Excel Examples:
In this example, you will notice the simple procedure of calculating the WACC in Excel. Let’s follow the steps for WACC calculation:
Calculate We & Wd arguments.
In the next step, find the Cost of Equity (Ke).
First, you need to find the risk-free return values, market premium, and beta to calculate the Ke for a weighted average cost of capital. Google can help you find the first two values.
Now, the formula for Ke will give the value:
0.08378
In the next step, you need to find the Cost of Debt Kd for WACC in Excel.
To calculate the cost of debt Kd for WACC, you have to first find the Interest rate IR and Eff. Tax rate. The Value of Kd would be:
0.02101768189
In the next step, finally, the WACC will be calculated.
Now, put all the values you have calculated in the Excel format and apply the formula as well. You will get the value of WACC as:
0.0812445208 (8.12%)
To Wrap Up:
In this post, you have learned how to calculate the WACC in Excel as it is a vital value used for capital investment decisions. This value is known to be the average cost of capital for the company as well as its competitors. The weighted average cost of capital is calculated by the company and later it is compared with the competitors.
To calculate WACC, the cost of debt is considered to be a key element. In this post, all of these terms are described well enough so that you can have a clear mind. WACC becomes a prediction tool instead of a reserved method for decision-making.
