Page 26 - Economic Damage Calculations

the analysis, the expert may use either (1) the company's actual capital structure or (2) the company's op-
timal capital structure.

Depending on the quantity and quality of available data, any one of the models previously set forth may
be used to derive the cost of equity capital used in the WACC. The cost of debt capital is often derived
based on the weighted-average interest rate that the company actually pays on its interest-bearing debt or
on the specific cost of debt associated with the project at issue. The formula for computing the WACC is
presented as follows:

WACC = We(Ke) + Wd[Kdpt(1 − t)]
We = Weight of equity in the capital structure
Ke = Cost of equity, based on one of the models previously described

Wd = Weight of debt in the capital structure
Kdpt = Pre-tax cost of debt
t = Income tax rate fn 9

A simplified example of a WACC calculation follows:

Weight of Equity Capital in Capital Structure (We) 60.0%

Cost of Equity Capital (Ke) 20.0%
Weighted Cost of Equity Capital (We × Ke) 12.0%
Weight of Debt Capital in Capital Structure (Wd) 40.0%
Pre-Tax Cost of Debt Capital (Kdpt) 10.0%

Tax Rate (t) 35.0%
Weighted Cost of Debt Capital (Wd × Kdpt × (1 − t)) 2.6%
Weighted Average Cost of Capital (WACC) 14.6%

fn 9 This input is used to tax effect the cost of debt to capture the income tax benefit associated with the deductibility of interest. Alt-
hough damages awards are typically treated as taxable income, which normally results in damages calculations being performed pre-
tax, this does not mean that the weighted average cost of capital (WACC), even if used in a damages calculation, should not include
consideration of the tax effect on the debt component of the WACC.

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