WACC = (Wdebt(1-t)Kdebt)+(WpreferredKpreferred)+(WequityKequity) where
K=component cost of capital
W=weight of each component as percent of total capital
t = marginal corporate tax rate
There are several observations to consider when estimating a company’s WACC for example, all capital costs as well as the weights should be current and not historical. Also the cost of debt should be after corporate tax and not before. As we will see in the survey findings, this equation, combined with these observations can be helpful; however, there are still some difficult choices that would have to be made and the most troublesome component being the cost of equity capital.
The survey findings first show multiple similarities. The discounted cash flow is the dominant investment-evaluation technique and the WACC is the dominant discount rate used in the discounted cash flow analysis. Weights are based on market not book value mixes of debt and equity. The after-tax cost of debt is predominantly based on marginal pretax costs, and marginal or statutory tax rates. The CAPM is the dominant model for estimating the cost of equity, which in and of itself seems to be a bit