Weighted average cost of capital, or WACC, is a calculation of the costs that a company pays for all of its financing. A company can acquire financing from a variety of sources, including bank loans, equity debt and selling stock. When an investor looks at a company to determine whether to invest in its stock, he can use the company's investment portfolio to calculate WACC. A shrinking WACC value reflects that the company's costs for acquiring capital are going down, which should signal higher potential returns to the investor's portfolio.
The Securities and Exchange Commissions' Electronic Data Gathering, Analysis and Retrieval system, also known as EDGAR, is a database of the forms filed by each company related to their stock offerings. To calculate the weighted average cost of capital for a particular stock, access the company's investment portfolio prospectus through EDGAR, which should contain all of the variables needed.
Market Value of Debt Factor
To calculate the WACC, begin by determining the market value of debt factor. From the company's prospectus, subtract the company's tax rate from 1, then multiply that value times the current market interest rate. Multiply this product by a factor consisting of the market value of debt divided by the firm total value, which consists of the total of the company's preferred shares, common equity, retained earnings and debt.
Market Value of Preferred Shares Factor
To determine the market value of preferred shares factor, subtract the floatation costs of preferred shares from 1, then multiply this product times the market price of the preferred shares. Use this value to divide from the annual dividends for the preferred share, and multiply the quotient times the figure determined by the market value of preferred shares divided by the firm total value.
Market Value of Common Equity Factor
Calculate the market value of common equity factor by adding 1 to the constant growth rate of dividends and multiply this sum by the annual dividends. Divide this value by a factor calculated by subtracting the floatation costs from 1, and multiplying this value by the market price of shares. Add this quotient to the constant growth rate of dividends and multiply the resulting value by a factor consisting of the market value of common equity divided by the firm total value.
Market Value of Retained Earnings Factor
Compute the market value of retained earnings factor by adding the constant growth rate of dividends plus one and multiplying the sum times the annual dividends. Divide this value by the market price of common shares and add the product to the constant growth rate of dividends. Multiply this sum by a value calculated by dividing the market value of retained earnings by the firm total value.
Weighted Average Cost of Capital
With the four factors completed, add them together to get the weighted average cost of capital. Comparing this current value to previous WACC values will show whether the company's cost of acquiring financing is increasing or decreasing, which will give one indication of whether the stock price may go up or down in the near future.
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