Weighted Average Cost of Capital (WACC) Calculation - CFA® Level 1 Exam

WACC Calculation

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Question

Which of the following equations correctly illustrates the calculation of the Weighted Average Cost of Capital (WACC)?

Answers

A. None of these answers

B. {{Percentage of debt* [coupon on outstanding debt * (1 - combined state/federal tax rate)]} + {percentage of preferred stock * [annual preferred dividend/ (required rate of return)]} + {percentage of common equity * cost of common equity}}

C. {{Percentage of debt * [coupon on outstanding debt * (1 + combined state/federal tax rate)]} + {percentage of preferred stock * [annual preferred dividend/ (offering price - flotation costs)]} + {percentage of common equity * cost of common equity}}

D. {{Percentage of debt* [yield to maturity of outstanding debt * (1 - combined state/federal tax rate)]} + {percentage of preferred stock * [annual preferred dividend/(offering price - flotation costs)]} + {percentage of common equity * cost of common equity}}

E. {Average cost of equity + average cost of debt + average cost of preferred stock}* subjective divisor

F. {Percentage of debt * [coupon on outstanding debt * (1 + combined state/federal tax rate)]} + {percentage of preferred stock * [annual preferred dividend/ (offering price + flotation costs)]} + {percentage of common equity * cost of common equity}}

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Explanations

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A. B. C. D. E. F.

The Weighted Average Cost of Capital is a fundamentally important concept within the field of corporate finance, and the CFA candidate should have a complete understanding of both the mechanics of the WACC figure, as well as the relationships between its components. In calculating the cost of outstanding common equity, there exist three distinct methods, the Dividend-Yield-plus- Growth-Rate, or Discounted Cash Flow approach, the Capital Asset Pricing Model (CAPM), and the Bond-Yield-plus-Risk-Premium approach. It is important for the CFA candidate to have a complete understanding of each method, along with their weaknesses and advantages.

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