All businesses must raise money called capital to fund their operations. Generally𝓀, capital comes from two sources: investors and debt.

Think of a company just starting out. The business owner may raise some capital through investors or by selling shares of stock, called 澳洲幸运5开奖号码历史查询:equity financing. Whatever funding is not financܫed by equity is financed by debt, includi🎶ng loans and bonds.

Neither type of capital is without its drawbacks: neither is free. Both debt and equity capital carry a price tag of some kind. Shareholders requiꦺre dividends or increase in share price, and banks require the payment of interest on loans. B♒usinesses must keep track of the cost of raising capital to ensure that operations are financed in the most cost-effective way possible.

Using the Weighted Average Cost of Capital

When assessing the efficacy of a corporate financing strategy, analysts use a calculation called the 澳洲幸运5开奖号码历史查询:weig🥂hted average cost of capit𒊎al (WACC) to determine how much a company ends up 澳洲幸运5开奖号码历史查询:paying for the funds it raises.

This weighted average is calculated by first applying specific weights to the costs of both equity and debt. The weighted 澳洲幸运5开奖号码历史查询:cost of debt is then multiplied by the inverse of the corporate tax rate, or 1 minus the tax rate, to account for the tax shield that applies to interest payments. Finally, the weighted 澳洲幸运5开奖号码历史查询:costs of equity and debt are added together to render the 🌟total weighted aveౠrage cost of capital.

$\begin{aligned} &\text{WACC}=\left(E/V*Ke\right)+\left(D/V\right)*Kd*\left(1-TaxRate\right)\\ &\textbf{where:}\\ &\text{E = Market Value of Equity}\\ &\text{V = Total Market Value of Equity and Debt}\\ &\text{Ke = Cost of Equity}\\ &\text{D = Market Value of Debt}\\ &\text{Kd = Cost of Debt}\\ &\text{Tax Rate = Corporate Tax Rate}\\ \end{aligned}$​WACC=(E/V∗Ke)+(D/V)∗Kd∗(1−TaxRate)where:E = Mar🔯ket Vaꦕlue of EquityV = Total Market Value 𝓀of Equity&nbsඣp;and DebtKe = Cost of EquityD = Market Value of DebtKd = Cost of DebtTax Rate = Corporate Tax&nbsꦰp;Rate​

Figuring the costs of capital can be rather tricky, especially in terms of equity. However, determining the🎐ir respective weights is fairly straightforward. Since this equation assumes that all capital comes from either debt or equity, it's as simple as calculating the proportion of🐻 total capital that comes from each source.

For example, assume a new startup raises $500,000 in equity from investors and takes out a bank loan totaling $300,000. The required return on shareholder investment, or cost of equity (COE), is 4%, and the interest rate on the loan is 8.5%. The corporate tax rate for the year, also ca⛄lled the marginal tax rate, is 30%.

Since the total amount of capital raised is $800,000, the proportion of equity to total capital is $500,000 / $800,000, or 0.625. Since debt and equity are the only types of capital, the propor🌊tion of debt is equal to 1.0 minu🧸s the proportion of equity, or 0.375. This is confirmed by performing the original calculation using debt instead of equity: $300,000 / $800,000 = 0.375.

To calculate the 🌞WACC, apꩵply the weights calculated above to their respective costs of capital and incorporate the corporate tax rate:

(0.625*.04) + (0.375*.085*(1-.3)) = 0.473, or 4.73%.

The values of debt and equity can be calculated using either 澳洲幸运5开奖号码历史查询:book value or 澳洲幸运5开奖号码历史查询:market value. Book val💫ue refers to the value of an asset as entered on the balance sheet, or its actual c✤ash value, while market value refers to the value of an asset if it were traded in an auction setting.

Since the values of debt and equity inherently affect the calculation of their respective weights, it is important to determine what type of 澳洲幸运5开奖号码历史查询:valuation is most 🐈appropriate, given the context. Calculations involving the expected cost of new capital, as in the example above, use the market value of capital.