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The Basics

DCF Key Questions

Combine Action Plans

Key Points

Weighted Average Cost of Capital (WACC)

What is it going to cost to raise the money in the future from debt, by selling stock or both?

The Weighted Average Cost of Capital is your market based cost of debt and cost of equity weighted by the porportion of your debt to equity. It is expressed as an interest rate.

Graphic showing 25% debt and 75% equityCalculate it by multiplying the proportion of your debt times your current interest rate on debt and the proportion of equity times the return expected by the market. For example:

(.25 X 9% cost of debt) + (.75 X 15% cost of equity) = 13.5%

Ibbotson Associates calculates these values for over 300 industries and Prof. Damadoran has similar data at his NYU site.

Competitive forces eventually reduce the premium people will pay to buy your stock and could increase your cost to borrow funds. Understanding how your firm's industry is reacting to competition is just as important as doing the math I describe here and is why advice from an experience facilitator or operator is critical to put the math in context.

Cost of debt

You estimate your borrowing rate from your recent borrowing, your debt rating from Moody's or Standard and Poors. Then adjust for the interest deducted from taxes by multiplying borrowing rate X (1-tax rate).

cost of debt = your borrowing rate X (1 - tax rate)

Your cost of debt is not your historical average. Your current debt load (leverage) and business conditions determine the interest rate for you'll get for next loan. The CFO's estimates are 8.5% to borrow and 28% for the tax rate, so this firm's cost of debt is

6.12% = 8.5% X (1 - .28)

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