The weighted average cost of capital (WACC) is a calculation of a company's cost of capital, or the minimum that a company must earn to satisfy all debts and support all assets. The calculation includes the company's debt and equity ratios, as well as all long-term debt. Companies usually do an internal WACC calculation to assess overall company health. The larger and more complex a company is, the harder it is to determine WACC. Unfortunately, only some of the information needed to calculate WACC can be found on a balance sheet.
Gathering Inputs and Information
When considering how to calculate WACC from financial statements, you'll need to start by gathering the required information from the balance sheet. Finding the information is the hardest step. Write out the full WACC equation and list the variables separately. It is a good idea to make a list of all your variables before rewriting the equation.
The WACC formula is as follows:
WACC = [(E/V) * Re] + [(D/V) * Rd * (1-Tc)]
- Re = cost of equity (expected rate of return on equity)
- Rd = cost of debt (expected rate of return on debt)
- E = market value of company equity
- D = market value of company debt
- V = total capital invested, which equals E + D
- E/V = percentage of financing that is equity
- D/V = percentage of financing that is debt
- Tc = corporate tax rate
Calculate the Components
Start calculating the variables. Start with the cost of equity and cost of debt. Some companies include these ratios on the balance sheet or income statement. It is a good idea to check both those reports and the executive summary at the beginning of financial statements—why do the calculations if the company has done them for you? Cost of equity, Re = (next year's dividends per share/current market value of stock) + growth rate of dividends. Note that this equation does not take preferred stock into account.
If next year's dividends are not provided, you can either guess or use current dividends. Current market value of stock will be included in a company's financial reports, but also can be found at Nasdaq.com. The after-tax cost of debt, Rd = yield to maturity of outstanding debt as a percentage * (1 – tax bracket) All these variables can be found in the balance sheet, income statement or annual financial reports for a publicly traded company.
Find current market values for equity (E) and debt (D). This is not the same as the owner's equity listed on the balance sheet. Owner's equity is book, or historical, value. Many companies include market value statistics in their financial reports, but you usually will not find it on the balance sheet. Go to SEC.gov to look up annual filings of public companies or ask for full financial reports.
Finalize the Calculation
Calculate the total market value (V) by adding (E + D). Next, look up the corporate tax rate. The effective tax rate listed on the income statement will tell you what taxes were charged. This is fine for a short-term analysis, but if you are thinking long-term, you will need to estimate the marginal tax rate for the future. Plug all the values you found into the equation. Solve for WACC. On the balance sheet and income statement, circle the numbers you used so you can find them again easily.