Weighted Average Cost of Capital (WACC)

What is Weighted Average Cost of Capital (WACC)

The weighted average cost of capital, or WACC, is the average cost of debt and equity financing that a company undertakes to finance its assets and operations.  Ideally, a mix of financing vehicles are used to create the lowest possible WACC.  Companies must be aware that the more leverage that they undertake, the greater return that an investor will demand and the greater the interest rate that a debtor will require for the increased risk of default. 

There is said to be a direct correlation between the long term decisions on defining the capital structure of a firm and the value of shareholders equity.  Companies have a variety of financing options that they may utilize to acquire the necessary capital.  Issuing common stock, preferred stock, short term debt, convertible bonds, warrants, options, etc. represent a few of the methods that a corporation may use to define its capital structure.

The WACC is a weighted average of the costs associated with each method of financing.  In general speak, the WACC represents the required rate of return for a project, or firm as a whole.  It is often used as the discount rate to determine the net present value of a project.

Part 2 - Calculating Weighted Average Cost of Capital (WACC)