The Weighted Average Cost of Capital (WACC)

Introduction to Financial Concepts in Python

Dakota Wixom

Quantitative Finance Analyst

What is WACC?

$ WACC = F_{Equity} * C_{Equity} + F_{Debt} * C_{Debt} * (1 - TR) $

$F_{Equity}: $ The proportion (%) of a company's financing via equity
$F_{Debt}: $ The proportion (%) of a company's financing via debt
$C_{Equity}: $ The cost of a company's equity
$C_{Debt}: $ The cost of a company's debt
$TR: $ The corporate tax rate

Proportion of financing

The proportion (%) of financing can be calculated as follows:

$ F_{Equity} = \frac{M_{Equity}}{M_{Total}} $

$ F_{Debt} = \frac{M_{Debt}}{M_{Total}} $

$ M_{Total} = M_{Debt} + M_{Equity} $

$ M_{Debt} $: Market value of a company's debt
$ M_{Equity} $: Market value of a company's equity
$ M_{Total} $: Total value of a company's financing

Example:

Calculate the WACC of a company with a 12% cost of debt, 14% cost of equity, 20% debt financing and 80% equity financing. Assume a 35% effective corporate tax rate.

percent_equity = 0.80
percent_debt = 0.20
cost_equity = 0.14
cost_debt = 0.12
tax_rate = 0.35
wacc = (percent_equity*cost_equity) + (percent_debt*cost_debt) * 
         (1 - tax_rate)
print(wacc)

0.1276

Discounting using WACC

Example:

Calculate the NPV of a project that produces $100 in cash flow every year for 5 years. Assume a WACC of 13%.

cf_project1 = np.repeat(100, 5)
npv_project1 = np.npv(0.13, cf_project1)
print(npv_project1)

397.45

Let's practice!

Introduction to Financial Concepts in Python