Chapter 12, Problem 2CTCR

Summary Introduction

To discuss: The preference on using book values for debt and equity while calculating the weighted average cost of capital (WACC).

Introduction:

The weighted average cost of capital (WACC) refers to the weighted average of the cost of debt after taxes and the cost of equity. The following formula helps to calculate the weighted average cost of capital (WACC):

$WACC=\left(\frac{E}{V}\right)\times R_E+\left[\left(\frac{D}{V}\right)\times R_D\times \left(1-T_C\right)\right]$

Where,

“WACC” refers to the weighted average cost of capital

“R_E” refers to the return on equity

“R_D” refers to the return on debt

“E” refers to the market value of equity capital

“D” refers to the market value of debt

“V” refers to the market value of total capital

“T_C” refers to the corporate tax rate