Weighted Average Cost of Capital (WACC)
What is Weighted Average Cost of Capital (WACC)
The weighted average cost of capital (WACC) is a measure of a company's overall cost of capital, which is the required rate of return that a company must earn to satisfy its shareholders and creditors. It represents the average cost of all the capital that a company has raised, including equity (such as common stock and preferred stock) and debt (such as bonds and loans).
To calculate WACC, the following steps are typically followed:
- Determine the company's cost of equity, which is the required rate of return that shareholders expect to receive on their investment.
- Determine the company's cost of debt, which is the interest rate that the company must pay on its debt.
- Determine the company's weight of equity and weight of debt, which are the proportions of the company's capital that are financed by equity and debt, respectively.
- Calculate the WACC by multiplying the cost of equity and weight of equity by the cost of debt and weight of debt, and then summing the results.
The WACC is important because it represents the minimum rate of return that a company must earn on its investments in order to meet the expectations of its shareholders and creditors. It is used to evaluate the feasibility of new investment opportunities and to determine the appropriate level of risk for a company's projects and operations.