{"id":20300,"date":"2019-04-04T09:00:20","date_gmt":"2019-04-04T14:00:20","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/kb\/%kb_category%\/wacc-cost-of-equity-and-cost-of-debt-in-a-dcf-1755\/"},"modified":"2024-12-16T23:41:08","modified_gmt":"2024-12-17T04:41:08","slug":"wacc-formula","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/discounted-cash-flow-analysis-dcf\/wacc-formula\/","title":{"rendered":"WACC, Cost of Equity, and Cost of Debt in a DCF (17:55)"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">WACC, Cost of Equity, and Cost of Debt in a DCF<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/discounted-cash-flow-analysis-dcf\/wacc-formula\/#Why_Do_WACC_the_Cost_of_Equity_and_the_Cost_of_Debt_Matter\">Why Do WACC, the Cost of Equity, and the Cost of Debt Matter?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/discounted-cash-flow-analysis-dcf\/wacc-formula\/#The_Most_Important_Concept%E2%80%A6\">The Most Important Concept\u2026<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/discounted-cash-flow-analysis-dcf\/wacc-formula\/#Changes_to_the_DCF_Analysis_and_the_Impact_on_Cost_of_Equity_Cost_of_Debt_WACC_and_Implied_Value\">Changes to the DCF Analysis and the Impact on Cost of Equity, Cost of Debt, WACC, and Implied Value:<\/a><\/li><\/ul><\/nav><\/div>\n\n<style>.enteremail__large--inline{margin:60px auto!important}<\/style>\n<p>In this <strong>WACC and Cost of Equity tutorial<\/strong>, you&#8217;ll learn how changes to assumptions in a <a href=\"https:\/\/www.mergersandinquisitions.com\/dcf-model\/\" target=\"_blank\" rel=\"noopener noreferrer\">DCF model<\/a> impact variables like the Cost of Equity, Cost of Debt.<\/p>\n<p>You&#8217;ll also learn about <strong>WACC (Weighted Average Cost of Capital)<\/strong> &#8211; and why it is not always so straightforward to answer these questions in interviews.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Why_Do_WACC_the_Cost_of_Equity_and_the_Cost_of_Debt_Matter\"><\/span>Why Do WACC, the Cost of Equity, and the Cost of Debt Matter?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>This is a VERY common interview question:<\/p>\n<p>&#8220;If a company goes from 10% debt to 30% debt, does its WACC increase or decrease?&#8221;<\/p>\n<p>&#8220;What if the Risk-Free Rate changes? How is everything else impacted?&#8221;<\/p>\n<p>&#8220;What if the company is bigger \/ smaller?&#8221;<\/p>\n<p>Plus, you need to use these concepts on the job all the time when valuing companies\u2026 these &#8220;costs&#8221; represent your<br \/>\nopportunity cost from investing in a specific company, and you use them to evaluate that company&#8217;s cash flows and determine<br \/>\nhow much the company is worth to you.<\/p>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<p>EX: If you can get a 10% yield by investing in other, similar companies in this market, you&#8217;d evaluate this company&#8217;s cash flows against that 10% <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/discount-rate\/\" target=\"_blank\" rel=\"noopener\">Discount Rate<\/a>&#8230;<\/p>\n<p>&#8230;and if this company&#8217;s debt, tax rate, or overall size changes, you better know how the discount rate also changes! It could easily change the company&#8217;s value to you, the investor.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"The_Most_Important_Concept%E2%80%A6\"><\/span>The Most Important Concept\u2026<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Everything is interrelated &#8211; in other words, more debt will impact BOTH the equity AND the debt investors!<\/p>\n<p>Why?<\/p>\n<p>Because additional leverage makes the company riskier for everyone involved. The chance of bankruptcy is higher, so the &#8220;cost&#8221; even to the equity investors increases.<\/p>\n<p>AND: Other variables like the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/risk-free-rate\/\" target=\"_blank\" rel=\"noopener\">Risk-Free Rate<\/a> will end up impacting everything, including Cost of Equity and Cost of Debt, because both of them are tied to overall interest rates on &#8220;safe&#8221; government bonds.<\/p>\n<p>Tricky: Some changes only make an impact when a company actually has debt (changes to the tax rate), and you can&#8217;t always predict how the value derived from a DCF will change in response to this.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Changes_to_the_DCF_Analysis_and_the_Impact_on_Cost_of_Equity_Cost_of_Debt_WACC_and_Implied_Value\"><\/span>Changes to the DCF Analysis and the Impact on Cost of Equity, Cost of Debt, WACC, and Implied Value:<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Smaller Company:<\/p>\n<p>Cost of Debt, Equity, and WACC are all higher.<\/p>\n<p>Bigger Company:<\/p>\n<p>Cost of Debt, Equity, and WACC are all lower.<\/p>\n<p>* Assuming the same capital structure percentages &#8211; if the capital structure is NOT the same, this could go either way.<\/p>\n<p>Emerging Market:<\/p>\n<p>Cost of Debt, Equity, and WACC are all higher.<\/p>\n<p>No Debt to Some Debt:<\/p>\n<p>Cost of Equity and Cost of Debt are higher. WACC is lower at first, but eventually higher.<\/p>\n<p>Some Debt to No Debt:<\/p>\n<p>Cost of Equity and Cost of Debt are lower. It&#8217;s impossible to say how WACC changes because it depends on where you are in the &#8220;U-shaped curve&#8221; &#8211; if you&#8217;re above the debt % that minimizes WACC, WACC will decrease.<\/p>\n<p>Otherwise, if you&#8217;re at that minimum or below it, WACC will increase.<\/p>\n<p>Higher Risk-Free Rate:<\/p>\n<p>Cost of Equity, Debt, and WACC are all higher; they&#8217;re all lower with a lower Risk-Free Rate.<\/p>\n<p>Higher Equity Risk Premium and Higher Beta:<\/p>\n<p>Cost of Equity is higher, and so is WACC; Cost of Debt doesn&#8217;t change in a predictable way in response to these.<\/p>\n<p>When these are lower, Cost of Equity and WACC are both lower.<\/p>\n<p>Higher Tax Rate:<\/p>\n<p>Cost of Equity, Debt, and WACC are all lower; they&#8217;re higher when the tax rate is lower.<\/p>\n<p>** Assumes the company has debt &#8211; if it does not, taxes don&#8217;t make an impact because there is no tax benefit to interest paid on debt.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>In this WACC and Cost of Equity tutorial, you&#8217;ll learn how changes to assumptions in a DCF impact variables like the Cost of Equity, Cost of Debt.<\/p>\n","protected":false},"featured_media":21902,"template":"","class_list":["post-20300","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-discounted-cash-flow-analysis-dcf"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/20300","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/21902"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=20300"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}