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Weighted Average Cost of Capital (WACC)

What is WACC (Weighted Average Cost of Capital)?

The Weighted Average Cost of Capital is a measurement of the firm’s cost of capital where each section is proportionately weighted. Some of the sources of capital that are included in the WACC are common stock, preferred stock, long-term debt, and bonds. This calculation lets a firm know how much interest they owe for each dollar they finance. It is also the investor’s opportunity cost of investing in the company since they are taking on a risk by doing so. Investors will look at the WACC if they want to see if an investment is worth it or not. For a firm, the Weighted Average Cost of Capital is the required return and therefore it is an important factor to consider when making decisions. Overall, it is the minimum rate of return a firm needs to yield returns for their investors.

How to find the WACC?

To find the Weighted Average Cost of Capital, multiply the weight of value for the debt and equity with the cost of the debt and equity. To find the weight of the equity and debt, divide market value of the equity and the market value of the debt by the total market value of the firm’s financing. This is just the market value of equity and debt added together. The value of the weighted cost of debt must then be multiplied by one minus the corporate tax rate. This is because the cost of debt is found after deducting taxes. Then, you add the equity cost and debt cost together to find the Weighted Average Cost of Capital. This calculation is hard to do because the cost of equity is not a constant value whereas the cost of debt is predetermined and relatively fixed.

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