WACC
What is WACC used for?
The cost of capital for any particular business or project is the rate of return required by the providers of capital (both debt and equity) having regard to the risk characteristics inherent in the project. Businesses or projects which are able to earn returns greater than the cost of capital add value for investors. Conversely, businesses or projects which, while they may still be profitable, produce returns less than the cost of capital "destroy" investor value.
Equity investors have two components for their cost of capital:
- an explicit opportunity cost such as dividend payments; and
- an implicit opportunity cost in the form of an expected cash equivalent gain in share price.
The return to debt investors is in the form of interest payments.
We can determine a specific WACC for your company, business or for a particular project.
For further information on cost of capital and other corporate finance services visit our Valuation & Strategy page.
PwC WACC formula
To calculate WACC, PwC uses the following weighted average cost of capital formula:
Where:
| R d | The pre-tax cost of debt, based on the current yield on traded company debt instruments or estimated, taking account of company gearing, size, industry risk, etc. |
| T c | The marginal corporate tax rate. |
| D, E & V |
D and E are the market values of the business' debt and equity respectively and V is the sum of D and E. Therefore, D/V and E/V represent the relative weightings of debt and equity employed in the business' operations. |
| R e | The cost of equity capital. |
The cost of equity capital for each company used in calculating WACC has been derived solely from share trading in the NZX and has not been 'blended' with the cost of equity capital for similar companies listed on overseas stock exchanges.
PwC applies the post investor tax specification of the CAPM in establishing the cost of equity for a business, using the following formula and inputs:
R e = R f ( 1 - T i ) + b e [R m - D m T m - R f ( 1-T i )]
Where:
| R f | The risk free rate of return is based on the yield on Government Stock. |
| T i | Investors' effective tax rate on interest and dividend income and capital gains. Because some investors are subject to capital gains tax in New Zealand, T i is not equal to the marginal personal income rate. |
| b e | Equity Beta |
[R m - D m T m - Rf (1-T i )]
Post Investor Tax Market Risk Premium, where:
| D m | The cash dividend yield on the market portfolio |
| T m | Tax parameter applicable to the market dividend yield |
We derive our estimate of the post investor tax market risk premium from PwC research on New Zealand equity market returns. Refer to our paper describing the methodology we have employed to estimate the market risk premium.
Please note that the above formula is our standard methodology, and is used to calculate WACC. In practice, we may apply a different formula in circumstances where our standard methodology is inappropriate.
For further information on how we derive our WACC please get in touch with our experts.
Technical note and disclaimer
Information Sources
Our industry sector classifications are as defined by the NZX. Industry sector averages for WACC are the market capitalisation weighted averages for those companies currently selected within each sector.
In calculating WACC and earnings multiples for each of the selected companies, we use information provided by S&P Capital IQ.
Technical Note
Our WACC estimates are prepared using a post-investor taxes specification of the Capital Asset Pricing Model (CAPM) to determine the cost of equity. The cost of equity capital for each company has been derived solely from share trading in the NZX and has not been 'blended' with the cost of equity capital for similar companies listed on overseas stock exchanges.
Risk Free Rate (Rf) is based on Government stock yields.
Our Market Risk Premium (MRP) is based on research undertaken on returns in the New Zealand equity market.
Equity beta estimates are based on an average of monthly returns over (up to) five years. The equity beta estimates incorporate a minimum asset beta of 0.35.
Disclaimer: The Appreciating Value and previously issued Cost of Capital Reports are intended only to be an overview of WACC. Users of this information are advised that, before acting on any matter arising on this web site content, they should consult a PwC Valuation & Strategy partner.
