Weighted AVERAGE Cost OF Capital (WACC) (German weighted average capital costs) designates a beginning belonging to the Discounted cash flow procedures of the assessment of company value.

The weighted average capital costs are used by many enterprises, in order to determine the discount interest rate in investment projects. The WACC Kapitalkostensatz gives for this an economically reasonable minimum net yield.

Companies finance themselves over two sources (the capital structure): Own capital funds and outside capital (indebtedness in the form of e.g. loans, bank credits ect.). The WACC sentence corresponds to the principal-weighted average of the different interest rates and minimum net yields.

Overview

The sense of the Discounted cash flow procedure consists in an exact (quantitative) determination of the tax benefit of a proportionate outside financing. Now the height of the tax benefit of the financing politics of the enterprise depends. In many cases only one taxation of enterprises (thus for example one body-expensively or trade tax) is subordinated, a taxation of the shareholders is neglected.

Now it is further accepted that the enterprise operates an market value-oriented financing in such a way specified (with an market value-oriented financing already today the future outside capital ratio, thus the relationship from outside capital to share value, will become in the entire future accurately given, deviations or other uncertainties impossible), then the use of the WACC beginning (Weighted AVERAGE Cost OF Capital) offers itself. The use of the WACC beginning is bound to the condition of an market value-oriented financing - the enterprise is market value-oriented financed differently than, then the correct enterprise value will not agree with the WACC value.

Beside the WACC beginning one can likewise use the TCF entrance or the FTE equation. All three procedures lead to the same enterprise value. Which of the three methods one depends used on which possesses information of the Bewerter. With the WACC procedure it is accepted that the Bewerter knows expected cash-flow of the undeserved enterprise and in addition the weighted capital costs of the indebted enterprise. Both the FTE as well as the TCF procedure meet other acceptance regarding these information.

Computation of the WACC

The WACC is defined as:

C \ = \ \ left ({E \ over K} \ right) \ cdot y \ + \ \ left ({D \ over K} \ right) \ cdot b (1-X_C)

how

\ K = D + E

using the following symbols:

This equation describes the situation with homogeneous share and outside capital. If the capital contains e.g. additionally preferred share capital with another exchange rate value (e.g. registered shares with other nominal value, course however same number of votes) must the formula for everyone such additional capital class by a term is extended.

Evaluation effect of the taxes

The economists Merton Miller and Franco Modigliani showed in their theorems that in a perfect national economy (esp. without taxes) the enterprise value is independent of the debt ratio. Since however many governments permit a departure of the Fremdkapitalzinsen of the tax base, this creates an inclination to the outside financing.

Worth the indebted enterprise

V^l= \ sum_ {t=1} ^T \ frac {E [FCF^u_t]} {(1+WACC_0) \ cdots (1+WACC_ {T-1})}

with:

• V^l value of the indebted enterprise
• WACC_t weighted capital costs of the indebted enterprise at the time t
• E [FCF^u_t] expected cash-flow of the undeserved enterprise at the time t

The WACC procedure does not presuppose (contrary to the opinion) the Konstanz of the capital structure. The weighted capital costs can be computed with adjustment formulas so mentioned of the enterprise indebted by Miles Ezzel or Modigliani Miller from the own and outside capital costs.

Related links and literature

• WACC explains management encyclopedia in Manalex
• Scientific literature for the topic WACC and assessment of company value
• M. Miller and F. Modigliani: Corporate income taxes and the cost OF capital: A correction. American Economic Review, 48 (1963), P. 261-297.
• J. Miles and J. Ezzell: The weighted AVERAGEs cost OF capital, perfect capital markets and project life: A clarification. Journal OF Financial and quantitative analysis, 15 (1980), P. 719-730.

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