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The Weighted Average Cost of Capital or WACC refers to the financial ratio that is used to calculate a company’s cost of acquiring assets and financing by comparing the equity and debt structure of the business.
In other words, the WACC formula is to measure the true cost borrowing money and weight of debt through equity to support new capital purchases based on the company’s current equity and debt structure.
It is mainly used by the management to decide whether the company should use equity or debt to financially support new purchases. They make use of a WACC calculator to get the correct results.
WACC Formula:
The formula used to calculate WACC is:
WACC = ( VE x× Re ) + [ VD × Rd × (1−Tc) ]
Learning from WACC
Equity and debt are the two most crucial components of a company’s capital funding. Equity holders and lenders provides capital to receive certain returns on their funds. WACC indicates the return of that stakeholders can expect to receive. In other words, WACC is helps an investor to determine whether they should take the risk of investing money in a certain company.
A company’s WACC is the overall required return for a firm. This is why directors of a company often rely on WACC to make important decisions. WACC is the discount rate that is used for cash flows with a risk which is similar to that of the company.
Who uses WACC?
The WACC is frequently used by security analysts when assessing the value of investments. It can also be used as a hurdle rate against which investors and companies can gauge ROIC (return on invested capital) performance. Besides that WACC is also used to perform EVA (economic value-added) calculations.
Investors rely on WACC to decide whether an investment is worth pursuing or not. In simple words, WACC is the minimum acceptable ROI at which a firm yields returns for its investors.
Final Words
WACC is a very important formula for companies, investors, and stakeholders. Calculating WACC can be complicated at times. This is why they have the WACC calculator to make things easier.
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