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WACC: Definition And Formula For The Weighed-Average Cost Of Capital

Thursday, November 8th, 2012

Weighted-Average Cost of Capital (WACC) is the average of debt and equity capital costs that all publicly traded companies with debt and equity stakeholders incur as a cost of operating. Below we provide the details behind our WACC calculations.

Cost of Equity

  • Our cost of equity calculation is based on the Capital Asset Pricing Model methodology.
  • We use the market value of equity when calculating all Total Adjusted Market Capital ratios.
  • The Equity Risk Premium is calculated as the average of the current implied Equity Risk Premium and the historical implied Equity Risk Premium.
  • Though there are many other more complicated approaches for arriving at a firm’s cost of equity, we do not feel their additional complexity offers commensurate accuracy. CAPM is simple, gets us close enough and it is easy to implement consistently across all companies we analyze.
  • For Beta, we use consistent values to avoid this variable having an inappropriately large impact on the WACC calculation. We apply industry and sector averages for beta to individual companies. Industry and sector averages are based on the actual individual company betas, which we calculate based on daily prices over the past 5 years. We assign the industry or sector averages where we see individual beta values clustered most uniformly within industries or sectors, respectively.

Cost of Debt

  • The cost of debt capital should represent the business’ long-term marginal borrowing rate.
  • The Risk-Free Rate (RFR) is approximated by the 30-year Treasury Bond. If the 30-year rate is not available, the 20-year rate is used.
  • To the RFR, we add the debt spread associated with the debt rating on the company’s long-term debt.
  • The resulting pre-tax cost of debt is then multiplied by (1 – marginal tax rate).
  • We use debt ratings from Moody’s or S&P.

WACC Formula
WACC = ( Ke ) * (E/TC) + (Kd * (1-T)) * (D/TC)+Kp * (P/TC)
Where Ke = Cost of Equity
E = Total Equity
Kd = Cost of Debt
D = Total Debt
Kp = Cost of Preferred
P = Preferred Capital
E/TC = Equity Total Adjusted Market Capital Ratio
D/TC = Debt to Total Adjusted Market Capital Ratio
P/TC = Preferred Stock to Total Adjusted Market Capital Ratio
T = Tax Rate

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3 Comments

  1. varadha says:

    Terrific, yet simple analysis. I’ve always been a fan of ROIC as a measure of capital efficiency and believe that no size/growth outperformance can replace the quest for efficiency.

    Sort of like a big gas guzzling v8 that needs ever increasing gallons of fuel to keep its engine running

  2. David says:

    But Angie’s $90 per user acquisition cost is going to go away. That’s what their approach probably is. How would their outlook be if that $90 cost dropped down to a total cost of $3 per user?

  3. David:

    That would be great, but cost per user acquisition is not something that’s very easy for a company to fix. ANGI can slash their marketing budget to the bone, but then they would stop acquiring new members. They would probably lose members in fact, as their membership renewal rate is at ~75% and declining. If they cut marketing expense by ~95% as you seem to be suggesting, ANGI might be able to eke out 1 year of slight profits, but they would start shedding members and losing money very quickly. ANGI’s only hope is to keep its marketing budget high and hope it can reach the scale and brand awareness to be able to sustain its business while scaling back marketing costs enough to turn a profit. The fact that ANGI’s revenue growth is slowing down even as its marketing costs keep increasing makes it very unlikely it will achieve that goal.

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