Cost of capital (WACC)
Introduction
The weighted average cost of capital (CMPC) (in English, weighted average cost of capital, abbreviated as WACC) is the discount rate that should be used to determine the present value of a future cash flow, in a process of valuing companies, assets or projects. The cash flow used in a valuation process is the free cash flow, that is, the cash flow that the asset to be valued would generate if any cash inflow or outflow related to financing (generally financial expense and the tax savings generated by it) were not taken into account.
The CMPC is a basic concept of finance, and its theory and applications are found in most Corporate Finance textbooks. Two of these texts translated into Spanish are Ross et al. (2012)[1] and Brealey et al. (2004).[2].
Calculation
In the case of only debt (D) and equity (E) in a company (that is, in the simplest case), the CMPC is defined as:
Where:.
WACC: Weighted Average Cost of Capital;.
K: Shareholders' opportunity cost rate. Generally, the CAPM (capital asset pricing model) method is used to obtain it;
E: Amount of Equity or Capital contributed by shareholders;
D: Amount of financial debt incurred;
K: Cost rate of financial debt;.
T: Corporate tax rate, on company profits.
The term (1 – T) is known as “tax shield” or, in English, tax shield.
To correctly calculate this discount rate, you must use the market value of shareholders' equity and debt (as opposed to book value).
References
- [1] ↑ Ross, Stephen A.; Westerfield, Randolph W. y Jaffe, Jeffrey F. (2012). Finanzas Corporativas. 9ª Edición. México: McGraw-Hill.
- [2] ↑ Brealey, Richard A.; Myers, Stewart C. y Marcus, Alan J. (2004). Fundamentos de finanzas corporativas. 4ª Edición. Madrid. México: McGraw-Hill.