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Weighted average cost of capital (WACC)

Weighted average cost of capital (WACC)

Weighted average cost of capital (WACC) is a calculation of a firm’s cost of capital in which each category of capital is proportionately weighted. Companies raise money from all sources of capital, including common stock, preferred stock, bonds and any other long-term debt, are included in a WACC calculation. Different securities are expected to generate different returns.

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm’s cost of capital. The WACC represents the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Companies can use WACC to see if the investment projects available to them are worthwhile to undertake.

WACC can be expressed in the following formula:

WACC=E/V * Re + D/V*Rd*(1-Tc)

Where:
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 = total market value of the firm’s financing (equity and debt)
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

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