The Daily Technical #81: Do companies prefer straight-line or accelerated depreciation?

Good morning. Welcome to the 81st edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
What is the formula to calculate the weighted average cost of capital (WACC)?

The weighted average cost of capital (WACC) can be viewed as the opportunity cost of an investment based on comparable investments with similar risk profiles.

WACC is calculated by multiplying the equity weight by the cost of equity and adding it to the debt weight multiplied by the tax-affected cost of debt.

For the equity and debt values, the market values must be used rather than the book values.

WACC = (Equity / (Debt + Equity) × R equity) + [Debt / (Debt + Equity) × R debt (1 – t)]

Components:

• E/(D + E) and D/(D + E) are the equity and debt weights of the total capital structure

• R equity = Cost of Equity

• R debt = Cost of Debt, and must be tax-affected since interest is tax deductible

• t = Tax Rate %

Common Mistakes

1. Using book values instead of market values for equity and debt. Always ensure you reference current market values, as they reflect the most accurate picture for calculating WACC.

2. Overlooking the necessity of adjusting the cost of debt for taxes. Remember that interest is tax-deductible, so always multiply the cost of debt by (1 – tax rate) to account for this.

3. Leaving out components like the cost of equity or adjusted cost of debt. Double-check that both components, weighted appropriately, are included in your WACC calculation.

TL;DR

• WACC = [Equity weight × Cost of Equity] + [Debt weight × Tax-affected Cost of Debt]

  • Equity weight: Equity / (Debt + Equity)

  • Debt weight: Debt / (Debt + Equity)

• Use market values for equity and debt; avoid book values.

• Comprehend as investment's opportunity cost; align with risk profile.

TODAY’S QUESTION
Do companies prefer straight-line or accelerated depreciation?

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THAT’S A WRAP
See you tomorrow,

Mike Lukasevicz
Founder @ HirePrep