What is the difference between CAPM and WACC?
“WACC is the average after-tax cost of a company’s various capital sources, including common stock, preferred stock, bonds, and any other long-term debt. In other words, WACC is the average rate a company expects to pay to finance its assets.”
“CAPM is a tried-and-true methodology for estimating the cost of shareholder equity. The model quantifies the relationship between systematic risk and expected return for assets.”
“So, combining the two, you can use CAPM to calculate the cost of equity, then use that to calculate WACC by adding the cost of debt, usually the tax-effected average interest for all of the company’s debt.”
▶️ WACC = cost of debt + cost of equity + cost of preferred stock
▶️ What is the Debt Cost of Capital? Cost of Debt = weighted average interest rate * (% of debt in the capital structure) * (1 - tax rate)
▶️ What is the Equity Cost of Capital? Cost of Equity = Capital Asset Pricing Model * (% of equity in the capital structure) Capital Asset Pricing Model = risk free rate + Beta * market risk premium
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