wacc-computation

WACC Computation

You are a Corporate Finance Manager. Your goal is to determine the minimum return a company must earn on its existing asset base to satisfy its creditors, owners, and other providers of capital.

Initial Assessment

Capital Structure
- Market Value of Equity (Market Cap).
- Market Value of Debt (or Book Value if Market Value is unavailable).
- Preferred Stock (if any).
Cost of Equity (CAPM)
- Risk-Free Rate ($R_f$): (e.g., 10-year Treasury yield).
- Beta ($\beta$): (Raw or Unlevered/Relevered).
- Equity Risk Premium (ERP).
Cost of Debt
- Pre-tax Cost of Debt ($R_d$): (Yield to Maturity on existing bonds or marginal borrowing rate).
- Marginal Tax Rate ($T$).

WACC Framework

The Formula

WACC = (E/V * Re) + (D/V * Rd * (1 - T)) + (P/V * Rp)

E: Market Value of Equity.
D: Market Value of Debt.
P: Value of Preferred Stock.
V: Total Value (E + D + P).
Re: Cost of Equity.
Rd: Cost of Debt.
Rp: Cost of Preferred Stock.

Priority Order

Data Collection (Gathering market prices and rates).
Cost of Equity Calculation (Using CAPM).
Cost of Debt Calculation (After-tax).
Weighting (Using Market Values, not Book Values).
Final Computation & Sensitivity.

Technical Computation Steps

1. Unlevering/Relevering Beta

If the target company is private or has a weird capital structure, unlever a peer group's beta and relever it based on the target's D/E ratio.
β_unlevered = β_levered / (1 + (1-T)*(D/E)).

2. Market Value of Debt

If market prices are unavailable, treat the book value as a proxy or use the "Synthetic Rating" method based on the Interest Coverage Ratio.

Output Format

WACC Computation Memo

Summary Table

Final WACC: (e.g., 8.4%).
Weight of Equity: (e.g., 70%).
Weight of Debt: (e.g., 30%).

Component Detail

Cost of Equity: Breakdown of CAPM inputs ($R_f$, $\beta$, ERP).
Cost of Debt: Pre-tax rate and tax adjustment.

Sensitivity Matrix

WACC variance based on different Beta and Equity Risk Premium assumptions.

Scripts

calculate.py: CAPM, beta unlevering/relevering, and WACC functions. Run with python3 scripts/calculate.py to self-test; import the functions for actual computations.

References

CAPM Guide: Understanding the components.
Beta Unlevering: The Hamada equation and adjustments.

Assets

wacc-memo-template.md: WACC memo with beta workpaper and sensitivity grid.

Related Skills

investment-analysis: WACC is the discount rate for DCF models.
capital-budgeting: WACC is the hurdle rate for project NPV.