Page 329 - FM Integrated WorkBook STUDENT 2018-19

The cost of capital

The weighted average cost of capital

(WACC)

5.1 Assumption

Funds from each source of long-term finance are pooled together and used to
finance the various investment projects.

Therefore a weighted average cost of these sources of finance is appropriate to
evaluate the investment projects.

5.2 WACC calculation

 Calculate weights for each source of capital.

 Estimate the cost of each source of capital.

 Multiply proportion of total of each source by its cost and sum the results, using
the formula:

V e V d
WACC = ––––––– k e + ––––––– ‘k d(1 – T)’
V e + V d V e + V d

V e and V d are the market values of equity and of debt

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