## Weighted Average Cost of Capital (WACC)
WACC is the blended cost of all capital, weighted by each source's share in the total.
WACC = Σ (Wᵢ × Kᵢ)
Weights must sum to 1.
### Tax Treatment by Source
| Source | Cost | Tax Adjustment |
|---|
| Equity shares | Ke | None |
| Retained earnings | Kr | None |
| Preference shares | Kp | None — dividends not deductible |
| Debentures / Bonds | I × (1–t) / NP | Yes — interest deductible |
| Term loans | Rate × (1–t) | Yes |
### Book Value (BV) vs Market Value (MV) Weights
BV weights: from balance sheet. Retained earnings shown separately.
MV weights: equity = shares × market price; debt = face × (market price/100). Retained earnings are not listed separately — they are already embedded in the equity market price.
MV weights are theoretically preferred for investment decisions — they reflect current investor expectations.
### Step-by-Step Process
1. Compute Ke (Gordon/CAPM), Kp (approximation), Kd (after-tax)
2. Determine weights (BV or MV as specified)
3. Multiply cost × weight for each source
4. Sum all products
### Example 1
Q37 — WACC using MV weights (PYQ)
Capital: 2,00,000 equity shares at MV ₹30; 12% Pref ₹10L; 9% Deb ₹30L. Tax = 40%. D₁ = ₹3; g = 7%.
MV of equity = 2,00,000 × 30 = ₹60L
MV total = 60 + 10 + 30 = ₹100L
Ke = 3/30 + 7% = 10% + 7% = 17%
Kp = 12%
Kd = 9% × (1 – 0.40) = 5.4%
WACC = (60/100)×17 + (10/100)×12 + (30/100)×5.4
= 10.2 + 1.2 + 1.62 = 13.02%
### Example 2
Q38 — Current and revised WACC after new debt (PYQ)
Current: 6L shares × ₹600 MV = ₹3,600L equity; 12% Deb ₹180L; RE ₹120L (absorbed in equity MV). Tax = 30%.
Dividend = 24% × ₹100 FV = ₹24; g = 5%; D₁ = 24 × 1.05 = ₹25.20
Ke = 25.20/600 + 0.05 = 4.2% + 5% = 9.2%
Kd = 12% × 0.70 = 8.4%
Total MV = 3,600 + 180 = ₹3,780L
Current WACC = (3600/3780)×9.2 + (180/3780)×8.4
= 8.752 + 0.4 = 9.15%
New plan: ₹300L at 18% loan; MV of equity falls to ₹500/share
New equity MV = 6L × 500 = ₹3,000L; New Ke = 25.20/500 + 5% = 5.04% + 5% = 10.04%
New Kd_loan = 18% × 0.70 = 12.6%
Total MV = 3,000 + 180 + 300 = ₹3,480L
New WACC = (3000/3480)×10.04 + (180/3480)×8.4 + (300/3480)×12.6
= 8.655 + 0.434 + 1.086 = 10.18%
### Example 3
Q41 — WACC with multiple debt instruments (Study Material)
Equity ₹65L (Ke=16.30%); 12% Pref ₹12L; 15% Deb ₹20L; 10% Conv Deb ₹8L. Tax = 30%. Total = ₹105L.
Kp = 12%; Kd1 = 15%×0.70 = 10.5%; Kd2 = 10%×0.70 = 7.0%
WACC = (65/105)×16.30 + (12/105)×12 + (20/105)×10.5 + (8/105)×7
= 10.10 + 1.37 + 2.00 + 0.53 = 14.00%
### Example 4
Q40 — All-equity firm (Study Material)
Gamma Ltd: 5,00,000 shares at ex-div price ₹1.50; D₀ = 27 paise (constant, no growth)
Ke = 0.27/1.50 = 18%; No debt → WACC = 18%