
















Weighted
average cost of capital 













































In this
spreadsheet we will calculate weighted average cost of capital 










We will not
stop on detailed explanations and economic meanings of the variables, because
there is too much info on that in the web 




We will focus
on the main steps of WACC calculation
and different approaches applicable to each steps 







You should
know that there is no unique approach to WACC calculation and many analysts
create their own approaches and logic for WACC model 




















WACC 

































Traditional
formula for WACC calculation is: 





























WACC = We x Ce
+ Wp x Cp + Wd x Cd x (1  t) 












or 
















WACC = Weight of equity x Cost of equity + Weight of preferred
stock x Cost of preferred stock + Weight of debt x Cost of debt x ( 1  tax
rate) 




















Let's calculate
separately each of the elements in the formula above 



























We (Weight of
equity) = MVc / (MVc + MVp + MVd) = 











= Market value of common stock / (Market
value of common stock + Market value of preferred stock + Market value of
debt) 






















Ce (Cost of
Equity) = Rf + B x (Rm  Rf) = Risk free rate + Beta
x (Market return  Risk free rate) = Risk free rate + Beta x Equity risk
premium 



This is one of
the most important elements of WACC formula and one of the most difficult for
calculation. We'll return to this formula later in "Cost of equity"
part 


















Wp (Weight of
preferred stock) =
MVp / (MVc + MVp + MVd) = 










= Market value of preferred stock / (Market
value of common stock + Market value of preferred stock + Market value of
debt) 






















Cp (Cost of
preferred stocks) = Div / Price = Annual dividend on
preferred stock / Market price of the preferred stock 






















Wd (Weight of
debt) = MVd/ (MVc + MVp + MVd) = 












= Market value of debt / (Market value of
common stock + Market value of preferred stock + Market value of debt) 























Cd (Cost of
debt) = the yield of company’s bonds; if the company
has no bonds use the rate for company’s bank loan; if you have no information
on yields or rates 

but
you now that the company has a debt, use the yields of bonds for similar
companies' bonds (they should have same size, credit ratings, operate in the
same industry, i.e. 
they should be
similar in all possible ways) 






























t (tax rate) = the rate of corporate income tax in the country where
it is registered (where it pays corporate income tax) 






















Let's also look
at the formulas for some of the elements in the formulas above 



























Market value of common stocks (MVc) = number
of common stocks x current market price of common stocks 






Market value of preferred stocks (MVp) =
number of preferred stocks x current market price of preferred stocks 






Market value of debt (MVd) = Market value of
the issued bonds; if the company has no bonds, but have bank loans, use their
balance value for calculation; if the company 

has mixed debt structure, use debt value from
its balance sheet (Longterm debt + Shortterm debt) 







if the company has no debt than the Market
value of debt = 0 



























COST OF EQUITY 
































Cost of equity
is one of the key elements of WACC formula 




























The classic
formula for Cost of equity calculation is 












Ce (Cost of
Equity) = Rf + B x (Rm  Rf) = Risk free rate + Beta
x (Market return  Risk free rate) = Risk free rate + Beta x Equity risk premium 




















Let’s calculate
all the elements from this formula 





























Rf (Risk free
rate) is usually a yield for government's 10 year
bonds. In USA the yield of Treasury notes is usually used while for European
countries you can use 10 years German bonds 
Some analysts
use current 10Y rates (for US 10Y notes it is about 2.9% now, in Dec 2010), some prefer average
historical values, some use forecast for 10Y notes yields 


















When analysts
calculate cash flows not in $ or ˆ, but in some local currency, many of them
use local government's 10 years bonds yield nominated in local currency 


If there is no
such longterm debts available, you can use the rate for borrowings of the
most reliable and safest company in the country nominated in local currency 

Many
economists still argue on the definition of the risk free rate, because some
Emerging Markets countries defaulted on their debts in the past (for example
Russia, Argentina). 
Thus
we can not consider the yields of
their bonds as a risk free rate in a classic /traditional
interpretation. 






Anyway, you
can choose the approach which is more suitable for you and which you consider
logical for your situation 























More on
calculation of the risk free rate you can find on Aswath Damodaran's page 









http://pages.stern.nyu.edu/~adamodar/pdfiles/papers/riskfree.pdf 




























B (Beta)
calculation 















Beta describes
the relation of returns between the stock and the market. 



























The formula for
Beta is 














Beta = Cov (Rs; Rm) / Var (Rm) 






























Cov (Rs; Rm) is
the covariance of the stock's and market's returns 










You can
calculate covariance using COVAR function in excel (if you are interested you
can also look at the definition of covariance in excel) 




Var (Rm) is the
dispersion of market returns 












You can
calculate Var using VAR function in excel 





























Let’s explain
this step by step 














First download
the daily values of the market index and the stock prices in two columns.
Download the data for 1,2,3 or more years 




After that
calculate daily returns for the index and for the stock 











After that use
COVAR and VAR excel functions to calculate Beta 




























The example of
calculations in details you will find in "example" file 














































































Rm (Market
return) 
































Market return
is usually calculated as an average historical return of the country's index 








Usually
analysts use 30 years history…or 50…That is for you to decide 










For US stock
market I see Rm between 4% and 5.5% more often 




























Some
stock exchanges on Emerging Markets have a very short history. 










In this case
you can simply add Country Risk Premium to the historical return of a mature
market (well it's actually US stock market) 





















More on
calculation of the county risk premiums, as well as particular rates, you can
find on Aswath Damodaran's page: 





http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html 



























For example,
let's calculate Rm for Cuba 













We have 5%
market return in US and 11.25% country risk premium for Cuba (see the link
above), so Rm for Cuba = 5% + 11.25% = 16.25% 






































Now we can calculate
the basic cost of equity. 





























Some analysts
find this calculation not sufficient and add different premiums to the basic
cost of equity 







For example,
one of the most widely used premiums is liquidity premium 










Analysts add
0.53% liquidity premium to incorporate the risk of inability to sell the
stock immediately 







You
can add premiums for poor transparency, weak corporate governance, risk of
shareholders conflict etc 
























Although some
certain mathematical approaches to calculation of these premiums exist, many
analysts often simply use their judgments 





















COST OF DEBT 
































When you
determine the cost of debt for the company you simply try to find at which
rate the company is able to borrow money 






















If the company
has publicly traded bonds, your task
is very easy  just use the yield of this bond as a cost of debt 






Note: cost of
debt (rate) should be calculated for the debt nominated in the same currency
as your DCFmodel (Discount Cash Flows model) 




If you
calculate your DCFmodel in dollars, use dollar nominated bonds' yield 



























If
the company has no traded debt  try to find similar company with publicly
traded debt. You are lucky if you find a company of a similar size with the
same 


rating as
yours. Use this company's debt yield
as your cost of debt 










If it has no
rating, continue searching for a similar company with publicly traded bonds. 

























The company
should be similar in the structure of the capital, in size, it should be from
the same industry 
























If the company
has a debt in form of a bank loan, try to find the info on the rates on this
loan in company's reports (financial statements, MD&A, SEC fillings) 


The bank loan
is usually more expensive than bonds so you can make an adjustment if you
want 








If the company
does not disclose the info on its rates, search this info on banks web sites,
maybe ask your friends who work in bank about the possible loan rate for your
company 

















In the separate
excel files you can find examples of WACC calculation for different companies 

























EXAMPLE 1. For US incorporated company 





























We calculate
WACC for ConocoPhillips 






























EXAMPLE 2. For nonUS incorporated company 





























We calculate
WACC for Brazilian Petrobras 





























































































































































































































































































































































































































































































































































































