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Subject 5. Weighted Average Cost of Capital PDF Download
Capital is a necessary factor of production, and has a cost. The providers of capital require a return on their money. A firm must obviously ensure that stockholders or those that have lent the firm money, such as banks, receive the return that they seek. This return is the cost that the firm will incur to maintain those sources of capital. Therefore, the return that the providers of funds seek is equal to the cost to the firm of maintaining those funds.

The weighted average cost of capital (WACC) is defined as the weighted average cost of the component costs of debt and common stock/equity.

WACC = wD rD (1 - t) + wE rE

Note:

  • The weights are usually based on market values. Since a company's capital structure can change over time, the target capital structure should be used.
  • The tax rate should be the marginal tax rate.

Learning Outcome Statements

g. explain and calculate the weighted average cost of capital for a company;

CFA® 2023 Level I Curriculum, Volume 3, Module 21

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