Weighted Average Cost of Capital
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Insights on the Weighted Average Cost of Capital
What Is the Weighted Average Cost of Capital?
WACC is the average after-tax cost of a company’s various capital sources, including common stock, preferred stock, bonds, and any other long-term debt. In other words, WACC is the average rate a company expects to pay to finance its assets.
Why Using WACC Is Important?
WACC is a formula that gives insight into how much interest a company owes for each dollar it finances. Analysts use WACC to assess the value of an investment. WACC is a key number used in discounted cash flow (DCF) analysis. Company management also uses WACC figures as a hurdle rate when choosing which projects to undertake.
What Is the WACC Used for?
WACC is used as a benchmark on whether to invest in a project or company. It’s an internal calculation to determine a company’s cost of capital. WACC may be used as the discount rate is time value of money calculations, and it may be used as the hurdle rate for NPV or IRR calculations for capital budgeting.
Limitations of WACC?
One downside to the WACC is that it assumes a set capital structure. That is, the WACC assumes that the current capital structure will remain the same in the future. Another limitation of WACC is the fact that there are various ways of calculating the formula, which can lead to different results. The WACC is also not suitable for accessing risky projects because to reflect the higher risk the cost of capital will be higher.
