The weighted average cost of capital -- WACC -- is a company's weighted average cost of equity and cost of debt. The cost of equity is the risk-free rate plus a risk premium. The cost of debt is equal to the tax-adjusted yield of a long-term bond held to maturity. An investment's net present value -- NPV -- is the discounted present value of its future cash flow stream using the weighted average cost of capital as the discount rate. The cost of debt is zero for companies with no debt. In that case, the discount rate is equal to the cost of equity.
Get the current risk-free rate. People often use Treasury yields for the risk-free rate because the U.S. government stands behind its bonds. The U.S. Treasury department's website, other websites and various media publications publish Treasury yields. A bond yield is equal to its interest payments divided by the current market price.
Find the beta, which is a volatility measure. Yahoo! Finance, as well as other sites, provides free online beta information for stocks. New York University professor Aswath Damodaran's website provides beta information for different industry sectors. You can use the beta of a comparable stock or an average industry beta.
Find the equity risk premium, which is equal to the historical market return minus the risk-free rate. However, you can simplify calculations by using published average risk premiums. Damodaran's summary tables show historical equity risk premiums in the 3 to 7 percent range. Adjust this rate for other risk factors, such as country risk and liquidity risk.
Calculate the cost of equity. Multiply the equity risk premium by the beta, and then add the result to the risk-free rate. For example, the average beta was 0.92 in the beverage business, according to Damodaran's January 2011 tables. If you use the 2010 equity risk premium of 5.2 percent and assume a risk-free Treasury yield of 2 percent, the cost of equity is equal to about 6.8 percent, or 2 percent plus (0.92 multiplied by 5.2 percent). As there is no debt, the weighted average cost of capital is equal to the cost of equity, or 6.8 percent.
Compute the net present value of an investment. The formula for a constant cash flow stream into perpetuity is the cash flow divided by the discount rate. Continuing with the example, if an investment's anticipated cash flow is $1 million, the net present value is $14.71 million ($1 million divided by 0.068).
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.