WACC: formula, balance calculation example

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Currently, in market conditions, the property of any company can be valued through its value. On the one hand, this is the company's own property, which is formed through the authorized capital, net profit. On the other hand, almost any firm uses credit borrowed funds (for example, from banks, from other persons, etc.)

All of these sources are cumulatively flowing into the organization, allowing it to operate under market conditions.

The developed concept of the cost of capital today is the basic one in economic theory. Its essence lies in the fact that the company's property has a fixed value, like any resource - this value must be taken into account in the process of functioning of the economic object, as well as when making investment decisions.

However, this concept is much broader than calculating the relative amount of cash payments to investors, it also characterizes the level of return on capital that was invested.

The concept of capital structure plays an important role in the formation of the company's market value. This is where the calculation of the WACC indicator comes in. So, when optimizing the structure of property, you canparallel to the minimization of its weighted average value and maximization of the market value of the firm. To this end, a whole system of interrelated criteria and methods has been developed.

In order to assess each source of capital, an assessment of the weighted average cost of capital is carried out, which is determined as the sum of all discounting components.

The value of the weighted average cost of capital can be used to determine the profitability of the company, as well as to determine the break-even sales volume and a number of financial indicators, including in the stock market.

Various methods for calculating the weighted average cost of capital may well be used in practice, where it is necessary to make management decisions in a short time.

Capital: Characteristics

The concept of "capital" means the value that is advanced into production with plans for profit and dividends.

On the one hand, capital is the sum of share premium and retained earnings, which relates to the interests of the owners of the organization, the funds of shareholders. On the other hand, it is the aggregate of all long-term financial sources of the company.

The cost of capital is understood as the total amount of funds that must be paid for the use of a certain amount of financial resources. It is expressed as a percentage of this volume.

Economic meaning of the indicator "cost of capital":

• for investors, this is the level of the cost of capital, which shows the rate of return on it;
• for organizations, these are the unit costs required to attract and maintain financial resources.

Main factors that affect the cost of capital:

• general financial environment;
• commodity market condition;
• average lending rate;
• availability of financial sources;
• company profitability;
• level of operating leverage;
• Equity concentration;
• operational risk;
• features of the company's industry.

Destination

Historically, the time of the beginning of the use of the WACC concept dates back to 1958 and is associated with the name of such scientists as Modigliani and Miller. They argued that the concept of the weighted average cost of capital can be defined as the sum of the shares of the company's funds. In this case, each share of the source must be discounted.

They associated this indicator with the minimum profitability threshold for an investor, which he receives as a result of investing his funds.

The studied indicator reflects the following points:

• negative WACC means the company's management is efficient, which indicates that the company is making economic profits;
• if the studied value is within the dynamics of return on assets between the value of "0" and the industry average value, then this situation indicates that the company's business is profitable, but not competitive;
• if the indicator under study is higher than the industry average return on assets, you canboldly assert about the unprofitable business of the company.

Concept

The concept of weighted average cost of capital is based on the following definitions:

• capital - company property that can be put into circulation in order to attract profit;
• price - the cost that is fixed when buying and selling capital, expressed as a percentage.

WACC is the minimum return on capital a company has invested. In fact, the meaning of this indicator is that an organization can make decisions on investing capital only when the level of their profitability is higher than or equal to the value of the weighted average cost.

Generalized calculation formula

The process of assessing the cost of capital takes place in several stages:

• determination of the main components - sources of capital formation;
• calculate the price of each source;
• calculation of the weighted average price using the unit weight of each item;
• measures to optimize the structure.

In this process, you should pay attention to the tax factor, since the income tax rate is taken into account in the calculations.

In a generalized version, the formula looks like this: WACC=Ʃ (BeCe)+(1-T) Ʃ(VdSd), where:

• Be - equity, share;
• Vd - borrowed capital, share;
• Xe - cost of equity;
• Сд – cost of borrowed capital;
• T is the income tax rate.

Features of the indicator

Let's highlight the main features of the indicator calculation formula:

• The purpose of the formula for calculating the indicator is that it allows you to evaluate not the value of the indicator itself. The meaning of the indicator is to apply the calculated value in the form of a discount factor when investing in the project;
• The weighted average cost of capital is fairly stable and reflects the optimal current capital structure of the company;
• The correctness of the WACC calculation is related to the inclusion of comparable indicators in the formula.

Using the indicator to evaluate investment projects

WACC is used as a discount rate for calculating the return on investment projects. In this case, the cost of equity is the profitability of alternative projects, since it is the indicator, and the value of the benefit that was missed. Such calculations make it possible to accept various investment projects.

Let's look at a specific example using the WACC formula.

Main initial data for calculations:

• profitability of project A - 50%, risk 50%;
• profitability of project B - 20%, risk 10%.

Calculate the profitability of project B from the profitability of project A: 50% - 20%=30%.

Comparing yield calculations:

• for A: 30%(1-0, 5)=15%;
• to B: 20%(1-0, 1)=18%.

It turns out that, if we want to get a yield of 15%, we risk halfcapital invested in project B. On the other hand, the implementation of low-risk projects guarantees a return of 18%.

Above, we considered options for estimating investments using the theory of opportunity costs.

CALC WACC

Let's consider the formula for calculating WACC for an enterprise: WACC=(USCA)+(UZCA), where:

• US - equity, share;
• CV – cost of equity;
• UZ – debt capital share;
• TsZ - the price of borrowed capital.

In this case, the value of the CA can be estimated as follows: CA=CHP/SC, where:

• PE - net profit of the company, thousand rubles;
• SK - equity capital of the company, thousand rubles.

The value of CZ can be estimated as follows: CZ=Prots/K(1-Kn), where:

• Percent - the amount of accrued interest, thousand rubles;
• К – amount of loans, thousand rubles;
• Kn - level of taxation.

The level of taxation is calculated by the formula: Kn=NP/BP, where:

• NP - income tax, thousand rubles;
• BP – profit before tax, RUB thousand

Balance calculation

Let's consider an example of the formula for calculating WACC by balance. For this purpose, the following steps must be followed:

• find the company's financial sources and costs;
• multiply the cost of long-term capital by a factor of 1 - the tax rate;
• determine the share of own and borrowed capital in the total amount of capital;
• calculate WACC.

Sample stepsWACC calculation (balance formula) is presented below according to the table.

Total capital	Balance line	Amount, thousand rubles.	Share, %	Pre-tax price, %	Price after taxes, %	Costs, %
Net worth	Page 1300	4206	62	13, 2	13, 2	8, 2
Long-term loans	Page 1400	1000	15	22	15, 4	2, 3
Short-term loans	Page 1500	1544	23	26	18, 2	4, 2
Total	-	6750	100	-	-	14, 7

Examples of WACC calculations

Let's consider an example of the WACC formula for the following input data:

Income tax	25431 thousand rubles
Balance sheet profit	41048 thousand rubles
Interest	13450 thousand rubles
Credits	17900 thousand rubles
Net profit	15617 thousand rubles
Net worth	103990 thousand rubles
Equity, share	0.4
Debt capital, share	0, 6

1. Calculation of the level of taxation: Kn=25431/41048=0, 62.
2. Calculation of the price of borrowed capital: CZ=13450/17900(1-0, 62)=0, 29.
3. Equity price calculation: TA=15617/103990=0, 15.
4. Calculation of WACC value: WACC=0, 40, 15+0, 60, 29=0, 2317, or 23, 17%. This indicator means that it is allowed to make investment decisions with a profitability level above 23.17% for the company, since this fact will bring positive results.

Let's consider the calculation of the cost of WACC on another example according to the table below.

Financial sources	Account estimate, thousand rubles	Share, %	Price, %
Shares (ordinary)	25000	41, 7	30, 2
Shares (preferred)	2500	4, 2	28, 7
Profit	7500	12, 5	35
Long-term loan	10000	16, 6	27, 7
Short-term loan	15000	25	16, 5
Total	60000	100	-

The following is an example of the WACC calculation formula: WACC=30, 2%0, 417+28, 7%0, 042+35%0, 125+27, 7%0, 17+16, 5%0, 25=26, 9%.

The calculation showed that the level of costs to maintain the economic potential of the company with the existing structure of the sources of the company's funds is, according to calculations, 26.9%. That is, an organization can make certain investment decisions, in which the level of profitability is not lower than 26.9%.

Therefore, in analysis, WACC is often associated with IRR. This relationship is expressed as follows: if the IRR value is greater than the WACC value, then it makes sense to invest. If the IRR is less than the WACC, then it is not worth investing. In the case when the IRR is equal to WACC, the investment breaks even.

Therefore, the WACC indicator is decisive in the study of the rationality of the structure of funding sources in the company.

WACC and accounts payable

Consider the WACC model of the firm's accounts payable formula.

WACC value is estimated without taxshield according to the formula: WACC \u003d DSSP + DZSSZS-DKZRMS, where:

• DS - share of equity in total funding sources;
• SP is the cost of raising equity capital;
• DZ - the share of borrowed funds in total sources of financing;
• WACC - weighted average borrowing rate;
• DKZ - share of net accounts payable in funding sources;
• SKZ is the value of net accounts payable.

Features of the indicator in our country

Calculation of the value of the weighted average rate in our country has a certain peculiarity: WACC=SKd(SK+2%)+ZKd(ZK+2%)(1-T), where:

• SKd – equity share, %;
• SK - equity, %;
• ZKd – share of borrowed capital, %;
• LC - borrowed capital, %;
• Т - tax rate, %.

The cost of borrowed funds is estimated as the average value of the refinancing rate in our country, which is set by the Central Bank. To calculate the average indicator, a period of 12 months is used.