Components of Weighted Average Cost of Capital (WACC)

Various components of WACC are: Market value of debt, Market value of equity, Cost of debt and Cost of equity

Market value of debt

The Market Value of Debt refers to the market price investors would be willing to buy a company’s debt for, which differs from the book value on the balance sheet. A company’s debt doesn’t always come in the form of publicly traded bonds, which have a specified market value. Instead, many companies own debt that can be classified as non-traded, such as bank loans. Because this debt is reported at book value or accounting value in the financial statements, it is the analysts’ responsibility to calculate the market value, which will be of major importance when calculating the company’s total Enterprise Value.

Market Value of Equity

A company’s Market Value of Equity is the current market price of company’s share multiplied by the number of all outstanding shares in the market. The market value of equity is also known as market capitalization. The formula to calculate Market Value of Equity is as follows :

   Market Value of Equity = Market price per share X Total number of outstanding shares

Cost of debt

The cost of debt is the interest cost that a firm would have to pay for borrowed capital. Interest cost at which the securities of the firm were issued is the existing cost of capital. This is of no use because for any new project, it is important to see the cost of debt on marginal borrowing by the firm for undertaking the project. This cost of debt can be derived by finding yield to maturity.

Cost of Equity

The cost of equity can be defined as the required rate of return an investor would expect against supplying capital. The Expected rate of return has a direct relation with risk. Higher the risk, higher would be the expected returns. Gordon’s dividend discount model and capital asset pricing model (CAPM) offers good insight into the concept and calculation of the cost of equity.