What exactly is WACC?

Thank you all for your hard work every day!

It has been a little while, but
today I will explain WACC.

[Who should read this]
・Those who want to understand economic news more deeply
・Those who want to stay one step ahead of those around them
・Those interested in management, etc.

I explained ROIC the other day.
http://note.com/sipk/n/n9df0ee03a479

WACC is something that often comes up
as a set with the topic of ROIC.

This time as well, rather than going into detailed content, I will explain it
so that you can grasp the concept roughly first.

In a nutshell, WACC is the
cost incurred to raise the funds
used by a company.

To use a personal example for procurement costs,
a home mortgage is easy to understand.

When you take out a loan, you pay interest, right?
If you borrow 30 million yen for a home mortgage and the annual interest is
2%, that is 600,000 yen.
Think of this 600,000 yen as the procurement cost.

Were you able to get a rough idea?

However, companies have two main ways of raising funds.
① Borrowing from banks, etc.
② Raising funds through stock issuance

① is the home mortgage case I just explained.
I will explain ② in a little more detail.

Normally, raising funds through stock issuance
carries no repayment obligation.

If a company's performance is poor and it goes bankrupt,
the order of repayment for raised funds is as follows:
① Borrowing from banks
② Shareholders if there is anything left over
※ If there are corporate bonds, etc., they fall between ① and ②.
　I will omit that here.

Think about this for a moment.
If you were in the position of a shareholder,
since you are taking a risk because your repayment priority is low,
you would want a return when the company makes a profit, right?

If the interest rate on borrowing from a bank for this company is 3%,
you would want a return of about 6% for shareholders who are taking risks...
that is the idea.

Therefore, although it is hard to see, in addition to the interest paid to banks,
there is also a cost incurred every year on funds raised from shareholders.
(Shareholder expected return. Dividends, etc., are easy to understand.)

I will omit the detailed formula for WACC here, but
the concept is something like this.
(I have changed the content slightly for clarity.)

WACC (Weighted Average Cost of Capital)
→ The sum of debt interest + shareholder expected return.

The name "weighted average cost" makes it difficult to understand, but
it is the following concept.

Funding from banks: 100 million yen (3% interest rate)
→ 3 million yen in interest
Funding from equity: 20 million yen (6% shareholder expected return)
→ 1.2 million yen in returns

Total funding: 120 million yen
Funding cost: 4.2 million yen
WACC: 3.5% (4.2 million yen ÷ 120 million yen)

It costs 4.2 million yen every year to raise 120 million yen.
The point is that when expressed as a rate (WACC), this is 3.5%!

The strict formula is different,
but I personally think it is easier to understand
if you grasp the concept first.

Do you have a bit of an image of it now?

I also used to have a strong aversion
to economic terms and strings of alphabet letters.
However, I found that once I grasped the big picture
and then looked into it more deeply,
I often thought, "This is actually quite simple!"
So I would be happy if this helps you understand iteven a little bit!

Next time, I would like to explain
the relationship between ROIC and WACC.

It motivates me, so I would be happy if you could
click the Like button!!