Industry-specific cost of capital
The freely accessible sample of the KPMG Valuation Data Source offers a collection of cost of capital analyses specifically for your industry. In the data extract, we provide you with user-friendly access to current and reliable cost of capital benchmarks.
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Information on the cost of capital
What is the cost of capital?
The cost of capital describes the costs incurred by a company to finance its capital requirements. At the same time, it reflects the return required by holders of equity and debt capital for taking on a specific entrepreneurial risk. To determine the required rate of return of investors, the Capital Asset Pricing Model (CAPM) is often applied in practice. According to the CAPM, the required rate of return comprises a risk-free interest rate and an additional company-specific risk premium. The weighted average cost of capital (WACC) consists of this calculated cost of equity and debt weighted with their respective capital ratio with respect to the total capital. Due to the recognition of the costs of debt financing when determining the tax base, this results in additional or lower taxes (tax shield) compared to purely equity-financed companies.
Different cash flow approaches
Depending on the approach chosen to derive the relevant cash flows, two corresponding types of weighted average cost of capital can be calculated: the free cash flow WACC and the total cash flow WACC. As the free cash flow does not consider the tax effect of debt financing, the free cash flow WACC is made up of the weighted expected return of all investors (holders of equity and debt capital) and the tax effect of debt financing (tax shield). By contrast, the total cash flow WACC solely considers the weighted expected returns of all investors, as the tax effect of debt financing is directly considered when deriving the total cash flow.
What the data extract provides
This data extract provides the weighted average cost of capital for 13 industries in accordance with the Global Industry Classification Standard (GICS). In addition, a summary shows the individual parameters, including the equity and debt ratios, included in the calculation of the weighted average cost of capital. While the WACC reflects the weighted expected return of all investors, the (levered) cost of equity only represents the required rate of return of equity investors. The KPMG Valuation Data Source provides you with online access to the cost of capital on a company-specific basis. Unlevered and levered costs of equity as well as the costs of debt can be calculated in a few clicks. This facilitates the implementation of investment calculations, company valuations and impairment tests.
Frequently asked questions
When to use the WACC and when to use the cost of equity?
Whether we use the weighted average cost of capital (WACC) or the (levered) cost of equity to derive the cost of capital depends on the valuation methodology and the sector in which the company operates. Particularly for companies in the financial sector (e.g. banks and insurance companies), we often use the levered cost of equity instead of the WACC as the relevant reference value. This is due to the differentiated meaning of “debt” and a heavy dependence on current interest rates. The KPMG Valuation Data Source therefore provides both, the levered cost of equity, which is more relevant for the financial sector, and the WACC, for all other sectors, as a basis for calculation.
Why do we need the cost of capital for business valuation?
For the valuation of a company, the expected future cash flows are discounted to the valuation date using a suitable discount rate. This discount rate represents the rate of return on an alternative investment that is adequate compared to the company being valued. The cash flows, which provide the basis for the valuation using the DCF method, can accrue to the holders of equity or debt capital on a proportionate basis. The respective cash flows must be discounted by the corresponding cost of capital.
How are the unlevered costs of equity calculated in accordance with the CAPM?
The unlevered cost of equity consists of the risk-free rate and the risk premium. The risk premium is the product of the company-specific beta factor and the market risk premium.
