WACC Exam Training
Exam questions on WACC rarely hand you every input. You usually need to build the cost of equity with CAPM, convert the cost of debt to after-tax, and work out market value weights first. This lesson is about putting those pieces together under exam conditions.
What you will learn
- How to set up a multi-step WACC exam question
- Finding cost of equity with CAPM inside a WACC problem
- Converting a bond yield into an after-tax cost of debt
- Calculating market value weights from share prices and debt values
- Adding preferred stock when a question includes it
The formulas
- P
- market value of preferred stock
- r_p
- cost of preferred stock
- V
- E + P + D
- Preferred dividend
- fixed annual dividend per preferred share
- β
- the company's equity beta
Worked example
Risk-free rate 3%, beta 1.4, market risk premium 5%. The company's bonds yield 7% and the tax rate is 30%. Equity is worth $50 million at market value and debt $30 million. Find WACC.
- Cost of equity = 3% + 1.4 × 5% = 10%
- After-tax cost of debt = 7% × (1 − 0.30) = 4.9%
- Weights: V = 50 + 30 = 80, so E ÷ V = 62.5% and D ÷ V = 37.5%
- Equity part = 62.5% × 10% = 6.25%; debt part = 37.5% × 4.9% ≈ 1.84%
- WACC = 6.25% + 1.84% ≈ 8.09%
Answer: WACC ≈ 8.09% (rounded to two decimals)
Common questions
What are the steps to solve a WACC problem?
First find the cost of each source of capital, usually cost of equity from CAPM and cost of debt from the bond yield. Then adjust debt for tax. Next work out market value weights. Finally multiply each cost by its weight and add them up.
How do you find the cost of debt for WACC?
Use the yield to maturity on the company's existing bonds, or the rate it would pay on new borrowing, not the coupon rate. Then multiply by one minus the tax rate to get the after-tax cost of debt.
How do you calculate market value weights for WACC?
Market value of equity is share price times shares outstanding. Market value of debt is the bonds' price times the number of bonds, or face value if no price is given. Divide each by the total of all sources.
How do you include preferred stock in WACC?
Treat preferred stock as a third source of capital. Its cost is the preferred dividend divided by the preferred share price, with no tax adjustment. Add a third term, its weight times its cost, to the WACC formula.