Concept of Weighted average cost of Capital

Generally the cost of capital of a firm is the weighted average cost of various source of finance used by it. If the firm uses n different sources of finance, its WACC is .

WACC = ∑xiki

where x is the proportion of ith source of finance and ki is the cost of the ith source of finance.
Suppose that a firm uses equity costing 15% and debt costing 8% . If the proportions in which the equity and debt are used are respectively 40% and 60%, its WACC will be:

WACC = Proportion of equity x Cost of equity + Proportion of debt x C =0.40x 15%+0.60x8%
=6%+4.8%
= 10.8%


The following three steps are involved in calculation of cost of capital (WACC)
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•Determinateof the cost of different components of capital
•Establish a set of weights (proportions)
•C-1culate the weighted average cost of capital

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