Weighted Average Cost of Capital (WACC) is the average rate of return a company must pay to its investors and lenders for using their capital, weighted by the proportion of debt and equity in its capital structure.
Weighted Average Cost of Capital (WACC) represents a company’s overall cost of financing. It combines the cost of equity (returns expected by shareholders) and the cost of debt (interest paid to lenders), weighted according to how much each source contributes to the total capital.
WACC is a critical concept in corporate finance and valuation. Companies use it as a discount rate to evaluate investment projects, acquisitions, and capital budgeting decisions. If a project’s expected return is higher than the WACC, it may create value for shareholders. If it is lower, the project may destroy value.
A lower WACC indicates cheaper financing and better financial efficiency, while a higher WACC suggests higher risk or expensive capital. Factors such as interest rates, market risk, tax rates, and capital structure directly affect WACC.
"If a company finances its operations with 60% equity and 40% debt, and the cost of equity is 12% while the cost of debt (after tax) is 6%, the company’s WACC will be the weighted average of these costs, reflecting its overall cost of capital."