Weighted Average Cost of Capital (WACC) is the expected rate of return that a company is expected to pay on average to all its financiers (both shareholders and creditors). WACC is determined as the weighted average of the costs of equity and debt capital. Ignoring taxes, the cost of debt capital is simply the interest rate on debt. However, considering specific tax laws, the after-tax cost of debt capital should be taken into account.
The formula for Weighted Average Cost of Capital can be expressed as:
$$r_{wacc}=\frac{D}{D+E}\times r_{d}\times(1-t)+\frac{E}{D+E}\times r_{e}$$
D— total debt of the company;
rd— cost of debt capital;
t— corporate tax rate;
E— total equity of the company;
re— cost of equity capital;
Equity and debt are usually expressed in market value, not book value.
FAQ
What is WACC?
It is the average cost a company pays for its capital from debt and equity.
Why is WACC important?
It is used in valuation, investment decisions, and comparing project returns.
What inputs are needed?
You need the cost of debt, cost of equity, capital structure, and tax rate.
