1 Identify the sources of capital

The first step is to identify the sources of capital that you use to finance your business or project. These can include equity, debt, preferred stock, or any other form of financing. You need to know the amount and proportion of each source of capital in your capital structure. For example, if you have $100 million of equity and $50 million of debt, your capital structure is 67% equity and 33% debt.

2 Find the cost of each source of capital

The second step is to find the cost of each source of capital. The cost of capital is the rate of return that investors require to invest in your business or project. The cost of equity is usually estimated using the capital asset pricing model (CAPM), which considers the risk-free rate, the market risk premium, and the beta of your company or project. The cost of debt is usually the interest rate that you pay on your loans or bonds. The cost of preferred stock is usually the dividend rate that you pay on your preferred shares. You need to find the cost of capital for each source of capital in your capital structure.

3 Weight the cost of each source of capital

The third step is to weight the cost of each source of capital by its proportion in your capital structure. This means that you multiply the cost of each source of capital by its percentage in your capital structure. For example, if your cost of equity is 12%, your cost of debt is 8%, and your capital structure is 67% equity and 33% debt, you weight the cost of equity by 0.67 and the cost of debt by 0.33.

4 Add the weighted costs of capital

The fourth and final step is to add the weighted costs of capital to get the WACC. This means that you sum up the products of the cost and weight of each source of capital in your capital structure. For example, if your weighted cost of equity is 0.67 x 12% = 8.04% and your weighted cost of debt is 0.33 x 8% = 2.64%, you add them up to get the WACC of 10.68%.

You have now learned how to calculate WACC for your financial model in four steps. WACC is a key input for your financial analysis and modeling, as it helps you determine the value and feasibility of your business or project. You can use WACC to discount your future cash flows, compare different investment opportunities, and optimize your capital structure.