A:

Weighted average cost of capital (WACC) is the average after-tax cost of a company’s various capital sources, including common stock, preferred stock, bonds and any other long-term debt. It is calculated by multiplying the cost of each capital source by its relevant weight, and then adding the products together to determine the WACC value.

Internal and external factors can cause problems for investors and analysts trying to assess the performance of a firm over time and in comparison with other firms in the industry. One external factor is the fluctuation of interest rates. The Federal Reserve Bank (the Fed) moderates long-term interest rates by targeting the federal funds rate - the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank overnight.

The Fed attempts to align the effective federal funds rate with the targeted rate by making additions to or subtractions from the money supply through open market operations (the buying and selling of U.S government securities, or Treasury bills).

As interest rates are moderated, it can cause fluctuations in the risk-free rate, the theoretical rate of return for an investment that has no risk of financial loss. This can affect a firm's WACC because the risk-free rate is an important factor in calculating the cost of capital. As the interest rate on debt fluctuates, it can be challenging for a company to predict the future costs of capital. As a result, a company can end up with greater or lesser capital costs than expected because of fluctuations in interest rates. A firm's cost of debt must be updated frequently as the cost of debt reacts to fluctuations in interest rates.

Other external factors that can affect WACC include corporate tax rates, economic conditions, and market conditions.

RELATED FAQS
  1. When does a growth stock turn into a value opportunity?

    Learn how fundamental analysts use valuation measures, such as the price-to-earnings ratio, to identify when a growth stock ... Read Answer >>
  2. What items are considered liquid assets?

    Learn what a liquid asset is, some examples of liquid assets, what a non-liquid asset is and what determines whether as asset ... Read Answer >>
  3. What is the formula for calculating EBITDA?

    Learn about EBITDA and how companies can manipulate this calculation to look more profitable. Read Answer >>
  4. What is the formula for calculating the debt-to-equity ratio?

    Find out how to use this fundamental financial ratio to help assess a company's performance. Read Answer >>
  5. How do I calculate the P/E ratio of a company?

    Find out how to calculate this common valuation ratio and what the results can tell you about a company's performance. Read Answer >>
  6. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Answer >>
Related Articles
  1. Investing

    Weighted Average Cost Of Capital (WACC)

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality
  2. Investing Basics

    Useful Balance Sheet Metrics

    These metrics can help you better understand the information found on balance sheets.
  3. Fundamental Analysis

    Understanding The Federal Reserve Balance Sheet

    We are all connected to the Fed's balance sheet, and the currency notes that we hold are its liabilities.
  4. Bonds & Fixed Income

    Investors Need A Good WACC

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality.
  5. Fundamental Analysis

    Apple Stock: An Earnings Case Study (AAPL)

    Discover an earnings case study on Apple, and learn about its EPS and revenue growth rates, and what analysts are projecting for Apple in 2016 and 2017.
  6. Term

    What Is Stockholders' Equity?

    Stockholders’ equity represents the equity that shareholders own in a company.
  7. Fundamental Analysis

    4 Challenges China Faces According to PIMCO

    Get the latest thoughts from Luke Spajic, executive vice president and portfolio manager in Singapore for PIMCO, on challenges facing China's economy.
  8. Markets

    Re-Emerging Markets?

    If you're wondering when will the emerging markets comeback be? Read on because is still young, but encouraging.
  9. Fundamental Analysis

    Alcoa vs. BHP Billiton: Which Is Better for My Portfolio?

    Obtain an up-to-date overview of BHP Billiton and Alcoa, Inc., two key players for investors seeking exposure to the aluminum market to consider.
  10. Sectors

    The Debt Report: The Telecom Sector

    Discover how America's telecommunications providers have been piling on debt since the Great Recession, and how part of the sector seems vulnerable.
RELATED TERMS
  1. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a ...
  2. Marginal Profit

    Marginal profit is the profit earned by a firm or individual ...
  3. Adjusted EBITDA

    Adjusted EBITDA is a measure computed for a company that looks ...
  4. Liability

    A company's legal debts or obligations that arise during the ...
  5. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure ...
  6. Short-Term Debt

    An account shown in the current liabilities portion of a company's ...

You May Also Like

Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  3. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  4. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  5. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  6. Economies Of Scale

    Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because ...
Trading Center