Weighted Average Cost of Capital (WACC)
The average rate a company pays to finance its assets, blending the costs of equity and debt based on their proportions in the capital structure.
Weighted Average Cost of Capital
The average rate a company pays to finance its assets, calculated by blending the costs of equity and debt based on their proportions in the capital structure.
For example, if a corporation is financed with 60% equity with a required return of 12% and 40% debt with an after-tax cost of 4%, its WACC would be 8.8% [(60% × 12%) + (40% × 4%)], representing the overall cost of capital for the enterprise.
WACC serves as the discount rate for evaluating investment opportunities, the hurdle rate for capital budgeting decisions, and a key component in business valuation models like discounted cash flow analysis. It reflects the minimum return a company must earn on existing assets to satisfy its capital providers. The formula incorporates the cost of each capital component (debt, preferred stock, common equity) weighted by its proportion in the company’s target capital structure, with debt cost adjusted for tax benefits since interest is tax-deductible. Rising WACC increases the required return threshold for new investments and typically reduces company valuation.