What is WACC?
The weighted average cost of capital (WACC) for a business is the sum of the cost of debt, weighted by the proportion of debt in the capital structure, and the cost of equity, weighted by the proportion of equity in the capital structure. The WACC reflects a rate of return that is commensurate with the risk of a business’s cash flows.
A WACC estimate has many uses and applications, including investment evaluation and pricing. As such, WACC is a relevant consideration in a range of contexts, including regulatory submissions, commercial negotiations, due diligence processes, and strategic planning. In a regulatory setting, the WACC establishes the rate of return that an entity is allowed to recover on its regulatory asset base (RAB).
The determination of WACC is a subjective exercise, because many of the parameters required for the calculation are forward-looking and not directly observable. This requires us to evaluate historical market data, academic evidence, regulatory precedent and financial market practice.
For the cost of equity, the Sharpe-Lintner Capital Asset Pricing Model (SL CAPM) is a seminal framework, although other models have emerged, such as the Black CAPM and the Fama-French model, which have been shown to more closely approximate observed asset returns. In regard to the cost of debt, the most common methodologies are the “on-the-day” approach and the trailing average approach. Both are calculated on the basis of observed corporate bond yields.
Synergies is well equipped to undertake WACC assessments in both a regulatory and commercial setting. Examples of our recent work include the following:
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Port of MelbourneSynergies assists the Port of Melbourne with the WACC analysis for its annual Tariff Compliance Statement (TCS) to the Essential Services Commission (ESC)
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Arc InfrastructureSynergies prepared a submission on behalf of Arc Infrastructure for the Economic Regulation Authority’s (ERA) 2018 WACC methodology review for regulated railways in Western Australia.
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Australian Rail Track Corporation (ARTC)Synergies has assisted ARTC with WACC assessments for both the Interstate and Hunter Valley access undertakings.
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