Capital Structure and Weighted Average Cost of Capital (WACC)
Understand your company's cost of financing and explore the optimal capital structure.
WACC Calculator
Adjust the values below to simulate changes in WACC. Enter all values as percentages (%) or in monetary units.
Cost of Capital (%)
Market Value of Capital
Calculation Results
Weighted Average Cost of Capital (WACC)
7.03%
Detailed Analysis
WACC Formula
WACC = (E/V) * Re + (P/V) * Rp + (D/V) * Rd * (1 - T)
Understanding Capital Structure
Capital structure is the mix of debt and equity a company uses to finance its operations and growth. Each financing method has unique characteristics, advantages, and disadvantages.
Debt Financing
This involves borrowing funds from others, creating an obligation to make regular interest payments. It has a higher priority for repayment, but the interest expense is tax-deductible.
- Types: Commercial paper, bonds, long-term loans, finance leases, etc.
- Pros: Tax savings from interest expense, no dilution of shareholder voting rights.
- Cons: Obligation to repay principal and interest, increased financial risk, risk of bankruptcy upon default.
Equity Financing
This involves raising funds by issuing stock, which means sharing ownership of the company. There is no repayment obligation, but there is an expectation of dividend payments, and it can dilute existing shareholders' stakes.
- Types: Preferred stock, common stock.
- Pros: No repayment obligation, strengthens financial health.
- Cons: Dilution of earnings per share (EPS), high issuance costs, dividends are not tax-deductible.
Cost of Capital Details
How is the cost of each component of capital that makes up WACC determined? Understanding how to calculate each cost is key to an accurate WACC calculation.
Cost of Debt
This is the interest cost associated with debt financing. Since interest expense provides a tax shield, the actual cost is calculated on an after-tax basis.
After-Tax Cost of Debt = Pre-Tax Cost of Debt × (1 - Corporate Tax Rate)
Cost of Preferred Stock
This is the dividend paid to preferred stockholders. Dividends are not tax-deductible.
Cost of Preferred Stock = Dividend per Share / Net Issuance Price
Cost of Retained Earnings
This is the minimum rate of return required by common stockholders on the capital they have invested in the company. It's an opportunity cost, and there are several ways to calculate it:
- Capital Asset Pricing Model (CAPM): Calculated by adding a market risk premium to the risk-free rate.
- Discounted Cash Flow (DCF) Model: Calculated based on future expected dividends and the current stock price.
- Bond Yield Plus Risk Premium (BYRP): Calculated by adding an equity risk premium to the company's bond yield.
Leverage and Risk
Leverage refers to the use of fixed costs to amplify the variability of profits. It is a critical factor to consider when determining capital structure.
Operating Leverage
Measures the degree to which a company uses fixed operating costs (rent, depreciation, etc.). High operating leverage means that operating income will change significantly with a change in sales.
- Characteristics: High in capital-intensive industries.
- Impact: High profitability after the break-even point, but a high risk of loss if sales decline due to the burden of fixed costs.
Financial Leverage
Measures the degree to which a company uses interest-bearing debt. High financial leverage means that earnings per share (EPS) will change significantly with a change in operating income.
- Characteristics: High in companies with a high debt-to-equity ratio.
- Impact: Maximizes shareholder returns if operating income is sufficient to cover interest costs, but carries a high risk of bankruptcy if unable to make debt payments.