WACC difference, question, between, capital, simple

karoliukas

It's a simple question but what's the difference between the marginal cost of capital and the WACC??

sdada

job's explanation chimes with the usage of marginal in other part of CFAI cirriculum ..ie marginal product - the extra output produced upon using one more unit of input



Edited 1 time(s). Last edit at Wednesday, December 2, 2009 at 07:16PM by ov25.

kasinkei

Not necessary. when you are financing with retained earnings (i.e., you are not asking for NEW capital), you are using capital from whatever EXISTING sources of capital you are using, so if your capital structure has debt/bond (i.e., you have financed your operations with debt/bond), you have to weight the cost of debt as well in your WACC. If you are like some of the high tech companies who do not use debt, then it is correct what you said since weight of debt =0.

johnnyBuz

In that case, I probably just made it up. ha.

So, when you're financing your projects with retained earnings you are not borrowing money so the WACC = cost of equity??

Wasteoftime

AHhh I think I see, appreciate you guys for taking the time, I really should have come on this forum more.

SO basically MCC is the cost of the taking on the new layer of capital whereas WACC is the cost of capital that you currently have...



One more question - what is cost of retained earnings?

orang3eph

I am not aware of the concept: cost of retained earnings
One normally talks about WACC, cost of capital, if equity or of debt, not retained earnings in general. As mentioned earlier, while you are financing your projects with retained earnings your cost of capital is WACC.

MonkeyBusiness

Weighted average cost of capital is the cost based on the current capital structure. If the question asks for what WACC will be after additional capital is raised, it will include the additional capital.

Marginal cost of capital is the cost of the increased capital (does not include the current capital cost).

Best way to explain is by example:

Company has $10,000,000 in long-term debt, and $10,000,000 in common equity outstanding. Cost of Equity = 20%. After-tax cost of debt = 10%.

WACC = .5*(20%) + .5*(10%) = 15%

Let's say company needs to raise $20,000,000 more of capital and wants to keep the same capital structure (50/50). However, the cost of the new debt will be 15%. The cost of the new equity will still be 20%.

Marginal Cost of Capital = .5*(20%) + .5*(15%) = 17.5%

WACC after raiding new capital = .5*(20%) + .25*(10%) + .25*(15%) = 16.25%

Bluetick1010

WACC is the weighted average cost of your existing capital.
If you still have earnings --> it is your margincal cost of cap.

If you have used up your retained earnings (i.e., run out of internally generated cash and need new external cash) --> you have to go outside and get new investors/borrow, then your marginal cost of cap is whatever the return theNEW investor requires.
Your WACC will be calculated anew taking in the weight and return of the new cap.