Calculating Weighted Average Cost of Capital

The Weighted Average Cost of Capital, or WACC, combines the costs of equity and debt, each weighted by its proportion in the company's overall financing structure.

WACC is crucial for determining the minimum acceptable return when evaluating investment opportunities.

WACC is calculated by multiplying the cost of equity by the proportion of equity in the total capital and adding it to the cost of debt adjusted for tax savings multiplied by the proportion of debt in the total capital.

Consider Pixel Corporation, which has two hundred thousand dollars in equity and one hundred thousand dollars in debt, for a total capital of three hundred thousand dollars. The company has a cost of equity of ten percent, a cost of debt of five percent, and a corporate tax rate of thirty percent.

The proportion of equity is sixty-six point six-seven percent, and the proportion of debt is thirty-three point three-three percent.

The after-tax cost of debt is three point five percent.

So, using the formula, Pixel Corporation's WACC is approximately seven point eight percent.

This figure is critical for the company as it represents the average return needed on investments to cover equity and debt financing costs.