The cost of capital is used for investment decisions: it is the rate at which cash flows are discounted in the NPV calculation or the rate at which IRR is compared.<\/p>\n\n\n\n
In other words, it is the minimum return rate that investments must generate for a company to meet the shareholders\u2019 requirements<\/strong> (cost of equity) and creditors\u2019 profitability requirements<\/strong> (cost of debt). The cost of capital represents the company\u2019s net financing.<\/p>\n\n\n\n <\/p>\n\n\n\n WACC = VDebt \/ (Ve + VDebt) x CoD x (1 – Tax) + Ve \/ (Ve + VDebt) x CoE<\/strong><\/p>\n\n\n\n Where:<\/p>\n\n\n\n VDebt<\/strong> = Value of the debt<\/p>\n\n\n\n Ve<\/strong> = Value of equity<\/p>\n\n\n\n CoD<\/strong> = Cost of debt (interest rate)<\/p>\n\n\n\n CoE<\/strong> = Cost of equity (required return by investors)<\/p>\n\n\n\n Tax<\/strong> = Corporate taxes (since interest on debt is tax-deductible)<\/p>\n\n\n\n <\/p>\n\n\n\n The cost of debt corresponds to the return expected by lenders, or in other words, the interest rate<\/strong>. A company\u2019s cost of debt should be based on the interest rate of the debt raised today<\/strong>, not on past debts. If the company has a current credit rating, that provides an ideal reference. If not, it may be necessary to estimate the current rate using the most recent debt issued. For listed companies, the interest rate can often be found in the annual report (10-K).<\/p>\n\n\n\nWACC formula<\/h2>\n\n\n\n
Focus on the cost of debt<\/h2>\n\n\n\n