Define and explain The weighted average cost of capital (WACC)

• Create a unique hypothetical weighted average cost of capital (WACC) and rate of return.
• Recommend whether or not the company should expand, and defend your position.

Respond:

 

The weighted average cost of capital (WACC) is the average rate of return a company is expected to pay to all its shareholders, including debt holders, equity shareholders, and performed equity shareholders.

WACC is used in financial modeling (it serves as the discount rate for calculating the net present value of a business). It’s also the “hurdle rate” that companies use when analyzing new projects or acquisition targets. If the company’s allocation can be expected to produce a return higher than its own cost of capital, then it’s typically a good use of funds.

Also, many investors don’t calculate WACC because it’s a little more complex than the other financial ratios.  But if you are one of those who would like to know how the weighted average cost of capital (WACC works, here’s the formula for you. WACC Formula = (E/V * Ke) + (D/V) * Kd * (1 – Tax rate).

• E = Market Value of Equity
• V = Total market value of equity & debt
• Ke = Cost of Equity
• D = Market Value of Debt
• Kd = Cost of Debt
• Tax Rate = Corporate Tax Rate

The WACC for Walmart is as follows:

V = E + D = $328 billion + $44 billion = $372 billion

The equity-linked cost of capital for Walmart is:

(E/V) x Re = (328 billion / 372 billion) x 5.59% = 4.93%

The debt component is:

(D/V) x Rd x (1 – Tc) = (44 billion / 372 billion) x 3.9% x (1 – 21%) = 0.32%

Using the above two computed figures, WACC for Walmart can be calculated as:

4.93% (weighted cost of equity) + 0.32% (weighted cost of debt) = 5.25%

On average, Walmart is paying around 5.25% per year as the cost of overall capital raised via a combination of debt and equity.  This Wal-Mart can expand to great things for its employees.