Rusq.org Explains What Wacc Means
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What is the definition of Wacc?
- WACC – Weighted Average Cost of Capital means weighted average cost of capital . Accordingly, Wacc is the cost of capital calculated by enterprises based on the proportion of capital they have used. The capital of the business will include: common shares, preferred shares, bonds and some other long-term debt.
- Typically, a company’s finances will be divided into two categories: debt and equity. Wacc is the average cost to effectively raise that amount, as a percentage of each source.
Meaning of Wacc Index
- In fact, the Wacc index plays a very important role for businesses in all business fields. By calculating Wacc, we can get an idea of how much it will cost a company per funded coin.
- Besides, Wacc is also used as a discount rate, serving to calculate the present value of the arising cash flows. As a result, businesses will easily evaluate and choose the right investment project for them.
- Usually, businesses will find ways to reduce Wacc through low-cost funding sources. For example, a bond issue has the potential to be more attractive than a stock issue if the yield is lower than the stock’s required yield.
- In addition, Wacc is also used to evaluate the profitable investment opportunities of a company because it represents the opportunity cost of the business. Accordingly, Wacc will act as the minimum rate of return to help businesses evaluate mergers and acquisitions as well as the financial model of internal investments.
How to calculate Wacc index
Currently, the weighted average cost of capital WACC will be calculated using the formula:
WACC = (E/V)*Re + (D/V)*Rd *(1-Tc)
- Re is the cost of equity
- Rd is the cost of debt
- E is the market value of total equity
- D is the market value of the firm’s total debt
- V is the total long-term capital of the enterprise
- Tc is corporate income tax
In the above formula, E/V are ratios that represent financial ratios based on equity. Meanwhile, the D/V ratio would represent a debt-based financial ratio.
WACC is the sum of the two terms [(E/V) * Re] and [(D/V) * Rd * (1-Tc)]. Specifically, the first part represents the weighted value of the equity capital, and the latter represents the weighted value of the debt linkage capital.
Illustrated example of how to calculate Wacc
An enterprise with a total capital of 5 billion VND is formed from the following basic sources:
|Capital||Value (million VND)||Proportion (%)|
According to calculations, the cost of using loans before tax is 10%/year. The cost of equity is 13.4%. Corporate income tax is 20%/year. Then, the company’s weighted average cost of capital WACC would be: WACC = 55% x 13.4% + 45% x 10% x (1 – 20%) = 10.97%.
Hopefully, through the content of information that we have just shared in the article, you can clearly understand what Wacc is and what this indicator means for businesses. Calculating Wacc with the correct formula and ensuring accuracy will create a solid premise for companies to build and expand business strategies. As a result, businesses will contribute to the overall growth of the country’s economy.
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