| Using The Weighted Average Cost Of Capital (WACC) To Improve Investment Decisions |
 |
 |
 |
| Written by Paul Markets |
| Saturday, 16 October 2010 22:41 |
|
When making investment decisions, the risk level of the investment should always be compared against the expected return. The challenge in this process is evaluating the riskiness of the company being investigated. One tool often used by financial analysts is the Weighted Average Cost of Capital.
When making investment decisions, the risk level of the investment should always be compared against the expected return. The challenge in this process is evaluating the riskiness of the company being investigated. One tool often used by financial analysts is the Weighted Average Cost of Capital. The WACC is defined as the expected rate of return for a company's investors, weighted by the proportion of each to the overall capital structure. The capital, such as common and preferred stock, along with the expected return from the capital is considered, along with any debt, and the cost of that debt. The two figures are then weighted by their proportion to the overall capital, to come up with a single number. A weighted average cost of capital calculation can be difficult. It requires lots of data, thousands of formulas, and consistent assumptions in order to properly function. Data needs to be real time. The free WACC discount rate analysis is completely new for anyone who attempts these difficult computations themselves. Different analyst can get different results, but they should all start from the same reliable base of analytical information. Determining the different variables that matter is a difficult task, but WikiWealth.com makes it much easier. An analyst can change numbers and estimates using WikiWealth's experimental analysis mode. Using the WACC cost of capital for investment decisions requires comparing the weighted average cost of capital to the investment goals. Low cost of capital implies low bond costs, thus low debt or solid credit worthiness, or low expected returns on capital, implying slow expected future growth. This information is usefully compared with investment goals. For capital preservation, companies with a low WACC cost of capital calculation are more likely suitable. For more aggressive investments, look for companies requiring a greater return on their capital, and thus a higher risk level. The weighted average cost of capital is also a way that companies can determine if their project is adding additional value, as measured by the difference between the cost of capital and the return on capital. When this calculation is positive, it means the project or company is adding net value, whereas, a negative value means the project or company is losing value for the investor. Find the risk of your investment. DISCLAIMER: This article is provided as information only and is not to be taken as financial advice. Looking to find the best analytical tools? See our WACC calculations, then visit www.wikiwealth.com to find the best WACC templates for you. |