how the weighted average cost of equity wace works
the weighted average cost of equity wace is essentially the same as the cost of equity that relates to the capital asset pricing model capm rather than simply averaging out the cost of equity a weighting is applied that reflects the mix of that equity type in the company at the time if the cost of equity was averaged without being weighted outliers in the cost of equity could cause an overstatement or understatement of the cost calculating the weighted average cost of equity wace calculating the weighted average cost of equity isn t as straightforward as calculating the cost of debt first you must calculate the cost of new common stock the cost of preferred stock and the cost of retained earnings separately the most common way to do this is the capm formula cost of equity risk free rate of return beta x market rate of return risk free rate of return generally speaking the cost of equity for common stock preferred stock and retained earnings will usually be within a tight range for this example let us assume the cost of common stock preferred stock and retained earnings are 14 12 and 11 respectively now calculate the portion of total equity that is occupied by each form of equity again let us assume this is 50 25 and 25 for common stock preferred stock and retained earnings respectively finally multiply the cost of each form of equity by its respective portion of total equity and sum of the values which results in the wace our example results in a wace of 19 5 wace 14 x 50 12 x 25 11 x 25 0 1275 or 12 8 simply averaging the cost of equity across categories in the example above would have yielded a cost of equity of 12 3 that said averaging is rarely done as the weighted average cost of equity is usually used as part of the larger calculation of a company s weighted average cost of capital wacc 