30. Calculation of Weighted Average Cost Of Capital from Financial Management Subject

Summary

In this educational session, students are introduced to the concept of Weighted Average Cost of Capital (WACC), a crucial metric in finance used to determine a company's cost of capital. The lecture covers the cost of various funding sources including equity shares, preference shares, and debentures. The instructor explains how to calculate the cost of each, taking into account dividends, market prices, and growth rates. A step-by-step calculation of WACC is demonstrated using a company's capital structure as an example, highlighting the importance of understanding the weighted impact of different funding sources on a company's overall capital cost.

Takeaways

• 📚 The lecture introduces the concept of Weighted Average Cost of Capital (WACC), which is a key metric in finance used to determine the cost of a company's capital.
• 💼 Companies raise funds by issuing shares, debentures, and different types of equity, each with its own cost of capital.
• 🔢 The cost of capital is calculated for various sources like equity shares, preference shares, and debentures, considering factors like dividends, market price, and growth rate.
• 📈 The formula for calculating the cost of equity shares involves the dividend per share, market price, and growth rate of dividends.
• 📉 For preference shares, the cost is calculated as the dividend rate divided by the net proceeds from issuing the shares.
• 💹 The cost of debentures is determined by the interest rate, net proceeds from issuing the debentures, and the tax rate, with a focus on the after-tax cost.
• 📊 WACC is computed by taking a weighted average of the costs of different capital components, with weights based on the proportion of each in the capital structure.
• 💡 The lecture emphasizes the importance of understanding WACC for financial decision-making, as it represents the overall cost of capital to a company.
• 📑 The script provides a detailed example of calculating WACC, illustrating the process step-by-step with a hypothetical company's capital structure.
• 🎓 The lecture concludes with encouragement for students to practice similar problems to solidify their understanding of WACC calculations.

Q & A

What is the primary topic discussed in the video script?

The primary topic discussed in the video script is the calculation of Weighted Average Cost of Capital (WACC).

What are the different components of capital a company might issue to raise funds?

A company might issue shares, which include equity shares and preference shares, and debentures to raise funds.

What is the significance of calculating the cost of capital?

Calculating the cost of capital is significant as it represents the cost of different sources of capital a company uses, which helps in making financial decisions and planning.

How is the cost of equity shares calculated when a growth rate is given?

The cost of equity shares is calculated using the formula: (Dividend + (Dividend * Growth Rate)) / Market Price * 100.

What is the formula used to calculate the cost of preference shares?

The cost of preference shares is calculated using the formula: Dividend / Net Proceeds * 100.

How is the cost of debentures calculated, and what role does the tax rate play in this calculation?

The cost of debentures is calculated using the formula: (Interest / (1 - Tax Rate) / Net Proceeds) * 100. The tax rate is used to determine the after-tax cost of debt.

What is the weighted average cost of capital and why is it important?

The weighted average cost of capital (WACC) is the average rate that a company expects to pay to finance its assets. It is important because it represents the overall cost of capital and is used as the discount rate in valuation models.

How are the weights for calculating WACC determined?

The weights for calculating WACC are determined by dividing the market value of each component of capital by the total market value of all components.

What is the formula for calculating the weighted cost of each component of capital?

The weighted cost of each component of capital is calculated by multiplying the weight of each component by its respective after-tax cost percentage.

What is the final step in calculating WACC after determining the weighted costs of each component?

The final step in calculating WACC is to sum up the weighted costs of all components to get the overall WACC.

Why is it important to understand the capital structure of a company when calculating WACC?

Understanding the capital structure of a company is important because it provides insight into the proportion of equity, preference shares, and debentures used, which directly influences the WACC calculation.