“WACC is given by weighted average of the marginal costs of financing for each type of financing used”
Why are marginal rates considered in WACC when previous debt could have been a rate of 15% and new debt issued could be at 20%. Then why is 20% only considered for WACC? Doesn’t the 15% have an effect too on the overall WACC?
Past bond rates are sunk costs. When you issue new bonds, you issue them at the new (marginal) cost of financing.
Yes but if the company is paying 15% on 1M (old debt) and 20% on new debt of 1M then the WACC should be 17.5% right and not 20%?
I don’t know where you get 17.5%.
If you get new money, it’ll cost you 20%. You’re WACC is 20%.
If you are paying 15% on old debt of 1M =150k per year and 20% on new debt= 200k. So you’re paying 350k interest payments yearly or 17.5% on the total debt. Is WACC used for a project or for the whole company. That would clear my doubt i guess.
Paarth777 you are confused because you are considering weighting of all the debt issued. WACC use marginal cost of new/latest/last dollar issued in debt and equity and weights of total outstanding debt and equity are used instead of all debt weighted by their outstanding amount and rates.
So would you say WACC takes a project on project basis?
No its company vide.
Hi Magician, just a clarification on what you wrote. So if a problem asks us to calculate the WACC and we are given two rates: one at issuance and the new one, we would use the new one as cost of debt?
That’s correct.
More specifically, you use the rate that will be in effect when you make the investment.
perfect
Thank you for the clarification