WACC (Weighted Average Cost of Capital)
Quick Answer
WACC is the average rate of return a company must earn on its investments to satisfy all of its stakeholders, including shareholders and debt holders.
Definition
WACC is the average rate of return a company must earn on its investments to satisfy all of its stakeholders, including shareholders and debt holders.
Explanation
WACC represents the blended cost of a company's capital structure, including equity and debt. It is calculated by weighting the cost of equity and the after-tax cost of debt by their respective proportions in the capital structure.
WACC is used as the discount rate in DCF valuation and as a hurdle rate for investment decisions. A company should only invest in projects that generate returns above its WACC, as lower returns would destroy shareholder value.
Example
A company with 60% equity (cost 12%) and 40% debt (cost 5%, tax rate 25%) has a WACC of: 0.6 × 12% + 0.4 × 5% × (1-0.25) = 8.7%.
Frequently Asked Questions
What is WACC (Weighted Average Cost of Capital)?
WACC is the average rate of return a company must earn on its investments to satisfy all of its stakeholders, including shareholders and debt holders.
How does WACC (Weighted Average Cost of Capital) work?
WACC represents the blended cost of a company's capital structure, including equity and debt. It is calculated by weighting the cost of equity and the after-tax cost of debt by their respective proportions in the capital structure.WACC is used as the discount rate in DCF valuation and as a hurdle rate for investment decisions. A company should only invest in projects that generate returns above its WACC, as lower returns would destroy shareholder value.
Can you give an example of WACC (Weighted Average Cost of Capital)?
A company with 60% equity (cost 12%) and 40% debt (cost 5%, tax rate 25%) has a WACC of: 0.6 × 12% + 0.4 × 5% × (1-0.25) = 8.7%.