Cost of Capital Calculation Example Help

Cost of Capital Calculation Examples, Samples, Concepts, Illustrations Help Online


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Cost of Capital Calculation Example Concept

Cost of capital can be defined as the opportunity cost of making a specific investment. It means the rate of return the investor could have earned by investing the same amount into a different investment having the same risk. The cost of capital includes the cost of equity and cost of debt. Calculation of both the cost of equity and debt is known as overall cost of capital. Cost of capital depends upon various factor such as operating history, profitability, credit worthiness etc.
The basic formula for calculating weighted average cost of capital is as follows
WACC = ((E/V) x Re) + [((D/V) x Rd) x (1-T)]
E is the Market value of the company’s equity
D is the Market value of the company’s debt
V = Total Market Value of the company (E + D)
Re = Cost of Equity
Rd = Cost of Debt
T= Tax Rate

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Cost of Capital Calculation Example Explanation

Let’s understand the concept with help of an example.
Example: Assume a company’s capital structure consists of 80% equity and 20% debt; its cost of equity is 20% and after-tax cost of debt is 8%. Therefore, its WACC would be (0.8 x 20%) + (0.2 x 8%) = 17.6%. This is the rate of return that the company expects to compensate to all its investors.
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