Weighted Average Cost Of Capital - WACC
Definition of 'Weighted Average Cost Of Capital - WACC'
A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk.
The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate
Businesses often discount cash flows at WACC to determine the Net Present Value (NPV) of a project, using the formula:
NPV = Present Value (PV) of the Cash Flows discounted at WACC.
Investopedia explains 'Weighted Average Cost Of Capital - WACC'
Broadly speaking, a company's assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances.
A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.
Need more WACC? Read Cost of Capital - Weighted Average Cost of Capital and Investors Need A Good WACC
Articles Of Interest
Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality
Calculate whether the market is paying too much for a particular stock.
The required rate of return is used by investors and corporations to evaluate investments. Find out how to calculate it.
The DCF method can be difficult to apply to real-life valuations. Find out where it comes up short.
Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality.
Looking for a formula to determine whether a company is creating wealth? Time to learn all about economic value added.
Learn how to filter out the noise of the market place in order to find a solid way of determing a company's value.
Leveraged buyouts allow investors to make large acquisitions without committing a lot of capital. But LBOs carry big risks and can result in huge returns or huge losses.
Would Eisenhower, Roosevelt and Kissinger have made good corporate executives? What about Alexander the Great?
These deals can make or break investors' returns. Find out how to tell the difference.