How do you calculate WACC?

How do you calculate WACC?

• A. Cost of Equity × (% Equity) + Cost of Debt × (% Debt) × (1 - Tax Rate) + Cost of Preferred × (% Preferred)
• B. Profit margin × tax rate
• C. Revenue × growth rate
• D. Cash flow × discount rate

Answer: (A)

WACC is the average rate a company must earn on its financing from all sources—equity, debt, and preferred stock—weighted by how much each source contributes to the total capital. To compute it, multiply the cost of each component by its share of the total financing and add them up. For debt, you use the after-tax cost because interest is tax-deductible, so the after-tax cost is Rd × (1 − Tc). The sum of these weighted costs gives the firm’s overall cost of capital. The option that matches this approach includes cost of equity times the equity percentage, plus cost of debt times the debt percentage times (1 − tax rate), plus cost of preferred times the preferred percentage, all added together. This directly implements the WACC calculation. The other choices don’t represent a blended, weighted cost of capital. Profit margin times tax rate isn’t a financing cost. Revenue times growth rate is a growth projection, not a cost of capital. Cash flow times discount rate is a generic discounting concept, not the weighted mix of financing costs.

WACC is the average rate a company must earn on its financing from all sources—equity, debt, and preferred stock—weighted by how much each source contributes to the total capital. To compute it, multiply the cost of each component by its share of the total financing and add them up. For debt, you use the after-tax cost because interest is tax-deductible, so the after-tax cost is Rd × (1 − Tc). The sum of these weighted costs gives the firm’s overall cost of capital.

The option that matches this approach includes cost of equity times the equity percentage, plus cost of debt times the debt percentage times (1 − tax rate), plus cost of preferred times the preferred percentage, all added together. This directly implements the WACC calculation.

The other choices don’t represent a blended, weighted cost of capital. Profit margin times tax rate isn’t a financing cost. Revenue times growth rate is a growth projection, not a cost of capital. Cash flow times discount rate is a generic discounting concept, not the weighted mix of financing costs.