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WACC (Weighted Average Cost of Capital)

WACC (Weighted Average Cost of Capital) is the cost a company bears to raise shareholders' equity and debt (loans and bonds), weighted by each source's respective funding proportion.

WACC = Cost of Equity × (Equity ÷ Total Capital) + Cost of Debt × (1 − Effective Tax Rate) × (Debt ÷ Total Capital)

What It Is Used For

WACC is mainly used in the DCF (discounted cash flow) method as the discount rate for converting a company's future cash flows into present value. It is one of the concepts that appears in corporate valuation contexts, including the calculation of theoretical stock prices.

How to Interpret It, and Points of Caution

There are several approaches to calculating the cost of equity, such as CAPM (the Capital Asset Pricing Model), and the result of the calculation changes depending on which assumptions are used. It should be kept in mind that WACC is ultimately an estimate based on a given set of assumptions, and there is no single absolute correct answer.

This article is provided for general informational purposes only and does not recommend or solicit the purchase or sale of any specific investment method or security. Final investment decisions are your own responsibility.

Frequently Asked Questions

How is WACC calculated?
It is calculated as the weighted average of the cost of equity and the cost of debt, weighted by their respective funding proportions. There are several approaches to calculating the cost of equity, such as CAPM (the Capital Asset Pricing Model), and the result changes depending on the assumptions used.
What is WACC used for?
It is mainly used in the DCF (discounted cash flow) method as the discount rate for converting future cash flows into present value. Whether ROIC exceeds WACC is also sometimes referenced as one indicator of whether a company is creating value.

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