1. Calculating WACC
This brings us to calculating WACC, it is the weighted average of the
cost of debt and the cost of equity,
the weights are determined by the relative amount of debt and equity financing
in a company's capital structure, which is debt plus equity.
The cost of debt is the yield to maturity on a company's debt,
not the coupon rate, the yield is the actual cost of debt based
on market conditions, which may differ from the coupon rate.
Since interest expense is usually tax deductible, we really need the after
tax cost of debt, which is the yield times one minus the tax
rate. The cost of equity is usually calculated using the capital asset pricing
model or CAPM. The basic CAPM calculation is the risk free rate plus
beta times the equity risk premium. Let's discuss more
on the CAPM.
2. Let's practice!