WACC is an indicator of the cost of capital. Cost of capital WACC: examples and calculation formula

WACC is an indicator of the cost of capital. Cost of capital WACC: examples and calculation formula

Modern market economy contributesformation of the value of property of any organization. This indicator is created under the influence of various cash flows. In the course of its activities, the company applies its own and borrowed capital. All these cash flows flow into the funds of the organization, form its assets.

WACC is an indicator of the cost of eacha separate source of financing for the company. This ensures the normal execution of the technological cycles. Controlling the cost of capital sources allows you to increase profits. Therefore, this important factor is necessarily considered by analysts. The essence of the presented method will be considered below.

General information

Weighted average cost of capital (WACC) is the indicator, which first began to be consideredanalysts in the middle of the last century. He was brought into use by such well-known economists as Miller and Modigliani. They proposed to consider the weighted average cost of capital. This indicator is determined to this day as the price of each share of the organization's funds.WACC is the indicator

To assess each sourcefinancing it is discounted. In this way, the level of profitability is calculated, and then the profitability of the business. At the same time, the minimum amount of payment to the investor is determined for the use of its financial resources in the process of the organization's activities.

Scope of the WACC indicatorThe company is determined when assessing the structureof capital. Its cost is not the same for each category. That is why the price of each source of financing is determined separately. Yield is also calculated for each separate category of capital. The difference between these indicators and the costs of their attraction allows you to determine the amount of cash flow. The result is discounted.

Financial sources

Cost of capital WACC, examples and calculation formulawhich will be presented below, requireto get into the organization of financing the company's activities. Property managed by the organization is presented in the active side of the balance sheet. The funds that formed these funds (raw materials, equipment, real estate, etc.) are indicated in the passive. These two sides of the balance are always equal. If this is not the case, mistakes are made in the financial statements.Cost of capital WACC

First of all, the company uses its own sources. These funds are formed at the stage of creating an organization. In subsequent years, some of the profits are attributed here (called unallocated).

Many companies use borrowed capital. In many cases this is advisable. In this case, the balance model can look like this:

0,9 + 0,1 = 1, where 0,9 - own capital, 0,1 - credit means.

Each presented category is considered separately, determining its cost. This allows you to optimize the structure of the balance.

Calculation

As already mentioned,WACC is an indicator of the average return on capital.To determine it, the generally accepted formula is used. In the simplest case, the calculation procedure is as follows:

WACC = Ас * Сс + Дз * Сз, where Ас and Дз - percentage indicator of the share of own and borrowed capital in the general structure, Сс and Сз - market cost of own and credit resources.Cost of capital WACC examples and calculation formula

To take into account the profit tax, it is necessary to supplement the above formula:

WACC = Ас * Сс (1-НП) + Дз * Сз, where НП is the profit tax.

This is the formula most often used by managers and analysts of the organization. Weighted average cost is an informative indicator, unlike the average price of capital.

Discounting

The WACC indicator depends onsituation in the capital market. To be able to correlate the real state of affairs of the company with existing trends in the entrepreneurial environment, the discount rate is applied.Weighted average cost of capital WACC is the indicator

Applying each source for fundingThe work of the company is associated with certain costs. Shareholders are paid dividends, and creditors - interest. This indicator can be expressed in the form of a coefficient or in a monetary form. Most often, the cost of funding sources is represented as interest.

The cost of a bank loan, for example, will bedetermined by annual interest. This is the discount rate. For the share capital, this indicator will equal the required profitability, which the owners of securities expect from providing their temporarily free funds for the use of the company.

Cost of own sources

WACC is an indicator,which takes into account, first of all, the costown capital. Any organization has it. Shareholders buy securities, investing them in the activities of their society. At the end of the reporting period, they want to make a profit. For this, a portion of the net profit after taxation is distributed among the participants. The other part is directed to the development of production.WACC is an indicator of the average return on equity

The more a company pays dividends, the higherwill be the market value of its shares. However, without funding its own development, the organization risks falling behind in technological development from its competitors. In this case even high dividends will not increase the value of shares on the stock exchange. Therefore, it is important to determine the optimal amount of funding for all funds.

The cost of internal sources is difficult to determine. Discounting is performed taking into account expected profitability of shareholders. It should not be less than the industry average.

Aspects of analysis

Cost of capital WACCshould be considered in the aspect of market orbalance sheet indicators. If the organization does not trade its shares on the stock market, the indicator will be calculated according to the second method. For this, the accounting data is applied.The WACC indicator depends on

If the organization forms its own capitalby means of shares in free trade, it is necessary to consider the indicator in terms of its market value. To do this, the analyst takes into account the results of the latest quotes. The number of all shares in circulation is multiplied by this figure. This is the real price of securities.

The same principle applies to all components of the organization's securities portfolio.

Example

To determinethe value of the WACC indicator,It is necessary to consider the presented methodology onexample. For example, the joint-stock company has attracted financial sources for its work for a total of 3.45 million rubles. It is necessary to calculate the weighted average price of capital. For this, some more data will be taken into account.WACC value

Own financial sources in the company are determined in the amount of 2.5 million rubles. Their yield (according to market quotes) is 20%.

The lender provided the company with its own funds inamount of 0.95 million rubles. The required return on its investment is about 18%. Using a weighted average indicator, the cost of capital is 0.19%.

Investment project

WACC is an indicator,allowing to calculate the optimal structurecapital for the company. Investors seek to invest their free funds in the most profitable projects with the least risk. On the part of the company, financing its activities exclusively through its own resources increases stability. However, the organization loses the benefits of using additional sources. Therefore, some of the borrowed funds should be used by the company for stable development.

The investor estimates the weighted average costThe company's capital to determine the appropriateness of the contribution. The company must provide the most acceptable conditions for the lender. If the stability indicators deteriorated in the dynamics, a large number of debts accumulated, the investor will not agree to finance the activities of such an organization. Therefore, the choice of the optimal capital structure is an important stage of strategic and current planning for any company.

All of the above allows us to conclude thatWACC is the indicatorweighted average cost of financial sources. On its basis, decisions are made on the organization of the capital structure. With the optimal ratio, it is possible to significantly increase the profit of the owners and investors of the company.

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