[Cash Flow King]

Thanks for the replies.

Someone mentioned cost of debt in another thread regarding WACC.
WACC is a useful tool for investors so I’ll talk about what it is and how you can use it.
WACC stands for weighted average cost of capital. It reflects what you are giving up in order to invest in a particular company.
What do you expect when you invest in a company? You expect to get something back in the future! WACC simply calculates what you, as an investor, can expect to get in return for taking on a risk.
Lets say that XYZ corp. collected $1MM from stockholders and $1MM from bondholders and they are requiring 10% and 5% returns respectively. In order to meet this requirement, the company must generate at least $150M ($100M to stock holders and $50M to bond holders) on the $2MM collected. The WACC in this case is 7.5% [ (100M+50M)/ 2M*100 or (10% + 5%)/ 2].
If the return that the company generates outweighs the WACC, the company is creating value.
So, how do you calculate these “required returns”?
We can’t obtain the exact average of what people are expecting in return for their investments. However, we can take a guess by calculating the company’s cost of equity (Re).
Re can be calculated by using a famous formula called the capital asset pricing model.
Re = Rf + Beta (Rm - Rf)
What do investors expect when they invest in individual stocks?
1) They expect to get a return above government treasuries (and alike) or the risk free rate (Rf).
2) They expect to get a return above the market average or the expected return on the market (Rm).
When you subtract Rf from Rm, you get the equity market premium. This simply measures the extra risk that the investor takes to invest in the market instead of T-bills.
If you multiply this by the beta and add Rf to it, you get Re. Beta compares the movement of a company’s stock price to the entire market. You can obtain this measure at Yahoo Finance.
With Re, you can calculate WACC.
The equation for WACC is E/ V * Re + D/V * Rd * (1 -Tc)
Where:
E = Equity
D = Debt
V = E + D
Re = Cost of Equity
Rd = Cost of Debt
Rt = Tax Rate

Note: Rm is roughly 12%. Use the interest rate of T-bills for Rf.