by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
You know how lenders are. We’re always talking about WACC-ing a guy who borrows money. Do you REALLY know what we’re tawkin’ about, though?
The Weighted Average Cost of Capital or WACC, is a corporate finance term used to measure the true cost of debt. You can find that figure in any bank’s annual report, on the Sources and Uses of Funds Page. They refer to it as a Cost of Funds.
It’s a pretty simple analysis. I use WACC analysis to determine whether you should refinance your home loan.
I can just WACC a property, I can WACC a certain person, I can even WACC your whole family if you want me to. Here’s how I would do it:
Let’s assume this homeowner has a $210,000 first mortgage at 6%, a $60,000 second mortgage at 9%, and $30,000 in consumer debt at 12%.
1- Add up all of your debt.
$210,000 + 60,000 + 30,000 = $300,000
2- Determine what the percentage each loan is to the sum of all the debts.
First mortgage= 70%, Second Mortgage= 20%, Consumer debt = 10%
3- Multiply the loan rate by that percentage for each loan.
First Mortgage= 70% * 6.0= 4.2, Second Mortgage= 20% * 9= 1.8, Consumer Debt= 10% * 12= 1.2
4- Add up all of those figures. That’s your WACC
WACC= 4.2 + 1.8 + 1.2 = 7.2%
Now, compare that WACC to the loan you could get to refinance those debts. If it’s lower than 7.2%, dat’s an offer you can’t refuse. Pretty simple, huh?
Fuhgeddaboudit.
P.S.- I tried this earlier and it seemed awfully confusing. You can figure for after-tax WACC to be more accurate but this post is probably easier to understand.
Keith Jeppson says:
Great use of weighted averages Brian. I can’t believe I’ve not seen it before. Do you always use it when there are tiers of debt?
May 6, 2007 — 8:39 pm
Morgan says:
Brian – great, easy demonstration of WACC, an essential tool for any serious loan officer when discussing refinancing options with potential customers. I’m sending this to everyone at my company … seriously.
MB
May 6, 2007 — 11:05 pm
Brian Brady says:
“Do you always use it when there are tiers of debt?”
Absolutely, Keith. I made the statement that I can WACC a property (analyze the loans on the property), WACC a person (analyze all the debt a person has), or WACC your whole family (analyze all of the family debts).
It’s helpful to determine the WACC before you make a recommendation (and usually makes the solution all the more palatable)
May 7, 2007 — 6:53 am
Christopher Smith says:
There’s an art to getting an idea across clearly when the concept includes a mathematical formula and you’ve struck the right balance here (and I agree, this post was more elegant than your previous effort).
Nicely done.
May 9, 2007 — 2:55 pm
Brian Brady says:
Thanks, Chris. I appreciate the comment.
May 9, 2007 — 3:08 pm
Brian Foster says:
Excellent post, should be very helpful in encouraging some on the fence customers to movre forward. I would like to ask your opinion on something, what should the price point be for the homeowner to move on the refinance. If they might only save an eighth is it still worthwhile for them? I am still pretty new in the business so forgive me if this seems a foolish question. Thank you
May 13, 2007 — 5:50 am