Definitions
What does WACC stand for?
Weighted Average Cost of Capital
What is the formula for calculating WACC?
WACC = (E/V * Re) + (D/V * Rd * (1-Tc))
If a company has $10 million in equity and $5 million in debt, what is the total value (V)?
$15 million
In times of rising interest rates, which type of company is more likely to face a higher WACC: a technology startup or an established utility company, and why?
A technology startup, because they are often more reliant on external financing and may face increased borrowing costs.
What is "equity financing"?
Raising capital by selling shares of the company
What is the definition of cost of equity?
The return that a company is required to deliver to its equity investors to compensate them for the risk they undertake by investing their capital
In the WACC formula, what does "Re" represent?
The cost of equity.
Given a cost of equity (Re) of 8% and a cost of debt (Rd) of 5%, what is the weighted cost of debt if the debt makes up 30% of the capital structure?
1,5%
Name an industry that typically has a higher WACC.
The technology industry.
What is "debt financing"?
Borrowing money, usually through loans or bonds.
What is meant by "capital structure"?
The mix of debt and equity financing a company uses.
In WACC, what does "D" stand for?
Debt
A company has a total value of $25 million (equity = $15 million, debt = $10 million). If the cost of equity is 12% and the cost of debt is 5%, what is its WACC assuming a tax rate of 30%?
During economic downturns, which type of company (e.g., consumer staples vs. luxury goods) generally experiences a lower WACC and why?
Consumer staples companies, because they have consistent demand even in economic downturns, making them less risky
Which is cheaper for companies, debt financing or equity financing, and why?
Debt financing, because interest payments are tax-deductible.
How is the market value of equity typically calculated?
The stock price multiplied by the number of outstanding shares.
What does "Tc" represent in the WACC formula?
The corporate tax rate
If the market value of equity is $20 million and the market value of debt is $5 million, what percentage of the capital is equity?
80%
How does an increasing interest rate environment typically affect a company’s WACC?
It generally increases WACC.
What is the term for the cost associated with issuing new equity?
Flotation costs
What is meant by "tax shield" in relation to debt?
The reduction in income taxes that results from deducting interest payments.
How do you calculate the cost of debt (Rd)?
The yield to maturity
If a firm has 70% equity with a cost of equity of 10% and 30% debt with a pre-tax cost of debt of 4%, calculate the WACC with a tax rate of 20%.
7,96%
Describe one reason why startups may have a higher WACC compared to established companies.
Higher perceived risk due to uncertainty in revenues
How can excessive debt affect a company's capital structure and WACC?
It can increase financial risk and raise the WACC due to higher perceived risk by investors