Weighted Average Cost of Equity – Definition

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Weighted Average Cost of Equity Definition

In finance and accounting, cost of equity in a company is determined using the weighted average cost of equity (WACE). Weighted average cost of equity (WACE) calculates the cost of equity in a company by allocated different weights to different aspects of the company’s equity.

Knowing the accurate cost of a company’s equity is important in determining the cost of capital of the company as well as the amount of compensation to be paid to investors. Also, when the cost of capital is determined, it is easy to make important decisions as to whether a company should take on a project or otherwise.

A Little More on What is Weighted Average Cost of Equity (WACE)

To calculate the weighted average cost of equity of a firm, here are the steps to follow;

  • Estimate the costs of new common stock, preferred stock am retained earnings of the firm.
  • Estimate the value of equity that each from of equity (new common stock, preferred stock am retained earnings) occupies.
  • Multiply each cost of equity by its proportion in the overall equity. This result gives us the WACE.

Why the Weighted Average Cost of Equity Matters

Investors consider the weighted average cost of equity to check how profitable an investment would be. In an acquisition, acquiring companies also check the WACE of the target company and use the value in assessing the future performance of the firm and future cash flows. Analysts also assess a firm using its weighted average cost of equity. This is with the aim of detecting deficiencies in the company’s approaches, if there are any and to introduce new methodologies.

References for “Weighted Average Cost of Equity (WACE)”

Academic research for “Weighted Average Cost of Equity (WACE)”

The weighted average cost of capital, perfect capital markets, and project life: a clarification, Miles, J. A., & Ezzell, J. R. (1980). The weighted average cost of capital, perfect capital markets, and project life: a clarification. Journal of financial and quantitative analysis, 15(3), 719-730.

Weighted average cost of capital in the theory of Modigliani–Miller, modified for a finite lifetime company, Brusov, P., Filatova, T., Orehova, N., & Brusova, N. (2011). Weighted average cost of capital in the theory of Modigliani–Miller, modified for a finite lifetime company. Applied Financial Economics, 21(11), 815-824.

Best practices in estimating the cost of capital: survey and synthesis, Bruner, R. F., Eades, K. M., Harris, R. S., & Higgins, R. C. (1998). Best practices in estimating the cost of capital: survey and synthesis. Financial practice and education, 8, 13-28.

Investment and the weighted average cost of capital, Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), 300-315.

From Modigliani–Miller to general theory of capital cost and capital structure of the company, Brusov, P., Filatova, T., Orehova, N., Brusov, P., & Brusova, N. (2011). From Modigliani–Miller to general theory of capital cost and capital structure of the company. Research Journal of Economics, Business and ICT, 2.

In defense of the weighted average cost of capital, Henderson Jr, G. V. (1979). In defense of the weighted average cost of capital. Financial Management, 57-61.

The weighted average cost of capital is not quite right, Miller, R. A. (2009). The weighted average cost of capital is not quite right. The Quarterly Review of Economics and Finance, 49(1), 128-138.

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