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WACC

WACC Full Form: Weighted Average Cost of Capital

WACC.webp

Key Highlights

  • WACC, or Weighted Average Cost of Capital, is essentially the average cost a company incurs to fund its operations, using a mix of both borrowed money and shareholders’ equity.

  • WACC = (Portion of Equity × Cost of Equity) + (Portion of Debt × Cost of Debt × (1 - Tax Rate))

What is WACC?

WACC, or Weighted Average Cost of Capital, is essentially the average cost a company incurs to fund its operations, using a mix of both borrowed money and shareholders’ equity. It gives a clear picture of how much it truly costs to keep the business running and growing. WACC is a crucial metric for business valuation, investment appraisal, and corporate finance decision-making.

How is WACC Calculated?

WACC = (Portion of Equity × Cost of Equity) + (Portion of Debt × Cost of Debt × (1 - Tax Rate))

  • Portion of Equity/Debt: How much of the company’s total funding comes from equity (stock) versus debt (loans).

  • Cost of Equity: What shareholders expect to earn (often estimated with a formula like CAPM, which considers market risk).

  • Cost of Debt: The interest a company pays on its loans or bonds, but with a twist- since interest payments reduce taxable income, the actual cost ends up being a bit lower.

  • Tax Rate: Since interest is tax-deductible, this reduces the “real” cost of debt.

Why Does WACC Matter?

1. Valuing a Business: WACC helps figure out what a company is worth by discounting its future earnings to today’s dollars. A lower WACC can make a company look more valuable.

2. Making Investment Choices: If a project’s expected return beats the WACC, it’s likely a good move—it means the company earns more than it costs to fund the project.

3. Balancing Debt and Equity: Companies tweak their mix of debt and equity to keep WACC low, saving money while keeping investors and lenders happy.