Module II· WACC & Capital StructureBasic
Question
What is the WACC formula?
Answer
Formula
```
WACC = (E/(D+E)) × Re + (D/(D+E)) × Rd × (1 − t)
```
Components
- E (EqV), D (Debt): Market values of equity value and debt
- Re: Cost of equity (CAPM)
- Rd: Pretax cost of debt (YTM of outstanding bonds)
- t: marginal tax rate
Example
Inputs:
- EqV: $600m
- Debt: $400m
- Re: 10%
- Rd: 5%
- t: 30%
Calculation:
```
EqV share = $600 / $1,000 = 60%
Debt share = $400 / $1,000 = 40%
WACC = 0.6 × 10% + 0.4 × 5% × 0.7
= 6.0% + 1.4%
= 7.4%
```
Logic
Weighted average of the cost of capital — weighted by share. (1−t) on Rd delivers the tax shield.
WACC is the discount rate for UFCF.