In this blog post, we will take you through our easy-to-use WACC calculator, which is completely free to download and use to aid you with your fundamental stock analysis.
WACC Formula & What it is Used For
A company can raise money in many different ways, including issuing ordinary and preferential stock, corporate bonds, and other forms of debt. The Weighted Average Cost of Capital (WACC) works out the average cost of all of these forms of fundraising to the company.
Knowing the Weighted Average Cost of Capital (WACC) can help companies determine whether an investment will create value for shareholders, i.e. is the investment going to generate earnings yield above the WACC, if it does not, then the company is then it is destroying the company’s wealth.
The WACC can also be utilised by investors as a standardised way of evaluating a company’s financial performance and forms a vital part of many valuation models, such as the Discounted Cash Flow Method (DCF).
How to Calculate Each of the Inputs in the WACC Formula
Cost of Equity Calculation
There are two methods we like to use when calculating the cost of equity for a company. The method we choose will depend on whether it is a dividend stock or a growth stock.
Firstly, for dividend stocks, we can rearrange Gordon’s Growth formula to calculate the cost of equity.
The CAPM model is another way of estimating a company’s cost of equity; we like to use this method for any company other than a dividend stock.
Where the risk-free rate is the return on short-term T-Bills, you can use the historical returns on the S&P500 as a proxy for the expected market return, and a company’s Beta is readily available on Google Finance.
Company beta is a measure of a stock’s volatility in relation to the overall market. It is calculated by comparing the stock’s returns to the returns of a benchmark index, such as the S&P 500.
A beta of 1 means that the stock has the same level of volatility as the benchmark index, while a beta greater than 1 indicates that the stock is more volatile than the market, and a beta less than 1 indicates that the stock is less volatile than the market.
Cost of Debt Calculation
There are also two methods you can use to estimate the cost of debt of a public company.
Firstly, you can take the interest expense directly from the latest income statement and divide this by the total debt. Interest is a tax-deductible expense, so you can multiply the result of this calculation by 1 minus the effective tax rate of the company to work out the true cost of debt.
It may be easier for you to rely on the company’s own workings – if you check the notes to the company’s latest 10K/10Q you can find the weighted average rate that the company is currently paying across all it’d debt obligations. This is usually buried down in the notes supporting the balance sheet.
There is a case for adding in a buffer in times when interest rates are either rising or falling if you want to capture a more realistic estimate of the cost of debt.
For example, the weighted average cost of debt in the extract above is based on debt on 31 December 2022. Since then, the Fed has increased its base rate more than once. The next time the company in question goes to raise additional or refinance some of its debt, it will pay a higher rate than it has in the past. Therefore, it would be wise to add a buffer on top of this figure to get a more accurate and up-to-date WACC.
Has the company’s credit rating changed recently? The data you may be using for the cost of debt calculation may be a couple of months old. In the intervening period, the credit rating could have been upgraded of downgraded which would impact the future cost of borrowing. You can check this out on sites such as Fitch Ratings and adjust the buffer as necessary.
Value of Debt and Equity
The value of equity is the number of outstanding shares multiplied by the current share price – this is also known as the market cap of a company. This number will be constantly fluctuating, so make sure to go to Google Finance, or Yahoo Finance to get the most up-to-date market cap.
The value of debt can be extracted straight from the company’s latest reported balance sheet.
Make sure to include both long term and short term debt that is included on the company’s latest balance sheet.
Effective Tax Rate
The best estimate to use for the tax rate is to calculate the company’s effective tax rate. This can be estimated by taking the following figures from the company’s income statement.
Tax provision / Net profit before tax *100
If you are not confident in preparing the calculation yourself, then you could always refer to the company’s latest 10K or 10Q, where the company will have also referenced its effective tax rate using the exact same calculation as above.
How to download your own copy of our WACC calculator
Once you click the link you will get access to our WACC calculator, but only as a viewer and not an editor.
In the top left-hand corner of the Google sheet – click ‘File’ and ‘Make a copy’ to create your own editable version of our template.
Disclaimer: This blog post is for informational and educational purposes only and should not be construed as financial advice.