Weighted average cost of capital (WACC)

Financial Management · Unit I · Topic 3 of 16 · 4 min read

Book-value and market-value weights, the weights method and the total-cost method, marginal cost of capital, and three paper problems solved: January 2026 (11.09% and 11.11%), Sri Company February 2025 (11.05% rising to 14.04%) and Tara Co. / August 2024 (11.08% and 11.94%).

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On this page

1. Meaning and method
2. Choice of weights
3. Worked problem: January 2026
4. Worked problem: Sri Company (February 2025)
5. Worked problem: Tara Co. Ltd (February 2025; same figures August 2024)
How this is examined

Cases checked to exist. Read the judgment before quoting a holding.

Every case cited here has been checked to exist — the citation resolves and names the right parties. The propositions attributed to each case have not been verified line by line against the judgment. Case names link through to the full judgment: read it before quoting a holding in an examination answer, and never carry a proposition from notes into court on trust.

The examinable core. A WACC table is the most frequent 10-mark problem in Unit I: January 2026, February 2025 (both options) and August 2024 all set one. Draw four columns — source, amount, weight, specific cost — then multiply and add. Do it twice when the question says “book value and market value”.

1. Meaning and method

The WACC (overall cost of capital, k_o) is the average of the specific costs of each source, each weighted by its share in the total capital:

k_o = k_dW_d + k_pW_p + k_eW_e + k_rW_r

All specific costs must be after tax. It is the discount rate for a project of the firm’s normal risk financed in the firm’s normal proportions.

Two ways to lay it out. The weights method multiplies each cost by its proportion. The total-cost method multiplies each amount by its cost to get a rupee cost, adds them, and divides by total capital. Both give the same answer; when a question asks for both (January 2026), show both.

2. Choice of weights

Book-value weights: from the balance sheet. Easy to obtain and stable, but historical.
Market-value weights: current market prices of the securities. Closer to the cost of raising funds today, and preferred in theory, but they fluctuate. Retained earnings have no separate market value: the market value of equity covers both, so it is split between equity and retained earnings in the ratio of their book values.
Marginal weights: the proportions in which new funds will be raised. The marginal cost of capital is the cost of the next rupee; it rises as the firm raises more.

3. Worked problem: January 2026

Equity 10,000 shares of Rs. 10 (market Rs. 15), k_e 12%; debentures 10,000 of Rs. 100 (market Rs. 120), k_d after tax 11%.

Source	Book Rs.	Cost	Book cost Rs.	Market Rs.	Market cost Rs.
Equity	1,00,000	12%	12,000	1,50,000	18,000
Debentures	10,00,000	11%	1,10,000	12,00,000	1,32,000
Total	11,00,000		1,22,000	13,50,000	1,50,000

Book: 1,22,000 ÷ 11,00,000 = 11.09%. Market: 1,50,000 ÷ 13,50,000 = 11.11%. By weights: book 0.0909 × 12 + 0.9091 × 11 = 1.09 + 10.00 = 11.09%; market 0.1111 × 12 + 0.8889 × 11 = 1.33 + 9.78 = 11.11%.

4. Worked problem: Sri Company (February 2025)

Equity Rs. 40,00,000, 6% preference Rs. 10,00,000, 8% debentures Rs. 30,00,000. Share price Rs. 20, expected dividend Rs. 2 growing at 7%, tax 40%.

k_e = 2/20 + 0.07 = 17%; k_p = 6%; k_d = 8 × 0.6 = 4.8%.

Source	Rs. lakh	Weight	Cost	W × k
Equity	40	0.500	17.0%	8.50
Preference	10	0.125	6.0%	0.75
8% debentures	30	0.375	4.8%	1.80
WACC	80	1.000		11.05%

(b) After Rs. 20,00,000 of 10% debentures, dividend Rs. 3, price Rs. 15, growth 7%: k_e = 3/15 + 0.07 = 27%; new debt 10 × 0.6 = 6%.

Source	Rs. lakh	Weight	Cost	W × k
Equity	40	0.40	27.0%	10.80
Preference	10	0.10	6.0%	0.60
8% debentures	30	0.30	4.8%	1.44
10% debentures	20	0.20	6.0%	1.20
WACC	100	1.00		14.04%

The WACC rises from 11.05% to 14.04%: the extra debt is cheap, but the fall in share price signals that shareholders now see more risk, and the rise in k_e outweighs the cheap debt. Comment on this in one line; it earns the last mark.

5. Worked problem: Tara Co. Ltd (February 2025; same figures August 2024)

Source	Book Rs.	Market Rs.	Cost	Book cost	Market cost
Debentures	4,00,000	3,80,000	5%	20,000	19,000
Equity	6,00,000	9,00,000	15%	90,000	1,35,000
Preference	1,00,000	1,10,000	8%	8,000	8,800
Retained earnings	2,00,000	3,00,000	13%	26,000	39,000
Total	13,00,000	16,90,000		1,44,000	2,01,800

Book-value WACC = 1,44,000 ÷ 13,00,000 = 11.08%. Market-value WACC = 2,01,800 ÷ 16,90,000 = 11.94%.

Trap. The question gives equity a market value of Rs. 12,00,000 and retained earnings a dash. The Rs. 12,00,000 is the market value of the whole equity interest, so it is split 6 : 2 (the book ratio) into Rs. 9,00,000 equity and Rs. 3,00,000 retained earnings, as in the table. If you instead give equity the full Rs. 12,00,000 and drop retained earnings, the answer is 2,07,800 ÷ 16,90,000 = 12.30%; say which treatment you used.

How this is examined

Expect one WACC problem in every paper, sometimes as the “OR” to a specific-cost problem. Write the formula, compute every specific cost after tax, lay out the table, and comment on the result. Theory questions on cost of capital use the companion note on specific costs.

Now try the real questions: Financial Management past question papers.