How is WACC calculated?

How is WACC calculated?

• A. Equity / (debt + equity) + debt / (equity + debt)
• B. Equity / (equity + debt) * cost of equity + debt / (equity + debt) * (cost of debt) * (1-t)
• C. Cost of equity + cost of debt
• D. Equity - debt + tax rate

Answer: (B)

The calculation of Weighted Average Cost of Capital (WACC) involves determining the average rates of return that a company is expected to pay to its equity and debt holders, weighted by the proportion of equity and debt in the company's capital structure. The correct approach takes into account the relative sizes of equity and debt financing, as well as the respective costs associated with each. In the right answer, the formula captures these aspects comprehensively: it calculates the portion of equity financing and multiplies it by the cost of equity, then calculates the portion of debt financing, multiplies it by the cost of debt, and adjusts for tax benefits (since interest expenses are tax-deductible). Specifically, the term "equity / (equity + debt)" gives the weight of equity, while "debt / (equity + debt)" gives the weight of debt. Multiplying these weights by their corresponding costs provides an average that accurately reflects the overall cost of capital. The inclusion of "(1-t)" accounts for the tax shield advantage of debt, which lowers the effective cost of debt for the company. This nuanced approach ensures that the WACC reflects the actual cost of capital from both equity and debt, providing a vital metric for investment decisions and financial

The calculation of Weighted Average Cost of Capital (WACC) involves determining the average rates of return that a company is expected to pay to its equity and debt holders, weighted by the proportion of equity and debt in the company's capital structure.

The correct approach takes into account the relative sizes of equity and debt financing, as well as the respective costs associated with each. In the right answer, the formula captures these aspects comprehensively: it calculates the portion of equity financing and multiplies it by the cost of equity, then calculates the portion of debt financing, multiplies it by the cost of debt, and adjusts for tax benefits (since interest expenses are tax-deductible).

Specifically, the term "equity / (equity + debt)" gives the weight of equity, while "debt / (equity + debt)" gives the weight of debt. Multiplying these weights by their corresponding costs provides an average that accurately reflects the overall cost of capital. The inclusion of "(1-t)" accounts for the tax shield advantage of debt, which lowers the effective cost of debt for the company.

This nuanced approach ensures that the WACC reflects the actual cost of capital from both equity and debt, providing a vital metric for investment decisions and financial