The weighted-average cost of capital Essay Sample

The weighted-average cost of capital Pages Download
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The cost of company’s capital can be define of as the minimum return required by providers of finance for investing in an asset, whether that is a project, a business unit or an entire company. It is important to reflect the capital structure used to finance the investment. To create a capital companies usually use a funds providing by creditors and shareholders. Managers use cost of capital as the discount rate in net present value (NPV) project appraisal techniques.1 The weighted-average cost of capital (WACC) represents the overall cost of capital for a company, including the costs of equity and cost of debt, weighted according to the proportion of each source of finance within the business. In easy words WACC measures a company’s cost to borrow money. The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:

Re = cost of equity ; Rd = cost of debt
E = market value of the firm’s equity
D = market value of the firm’s debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

The higher the WACC, the less possible it is that the company is creating value, because it has to overcome more expensive borrowing cost in order to make a profit. In practice, WACC is often used internally by managers, as a part of determining, whether it would be profitable for the company to finance a new project. For external investors, as one way to value the company’s shares, and decide, is it worth to invest or not.

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