Weighted Average Cost of Capital (WACC)
The blended rate of return a company must earn to satisfy all its capital providers — both debt and equity.
What is WACC?
The weighted average cost of capital (WACC) is the average rate of return a company is expected to pay to all of its security holders — shareholders and debt holders — weighted by each source's proportion of the total capital structure. WACC is calculated as: WACC = (E/V × Re) + (D/V × Rd × (1 − T)), where E is equity, D is debt, V is total capital, Re is cost of equity, Rd is cost of debt, and T is the tax rate. Because interest on debt is tax-deductible, the after-tax cost of debt is lower than the stated interest rate. WACC serves as the discount rate in discounted cash flow (DCF) analysis — a project must earn more than the WACC to create shareholder value.
Example
A company with 60% equity financed at a 12% cost of equity and 40% debt at a 6% interest rate with a 25% tax rate would have a WACC of: (0.60 × 12%) + (0.40 × 6% × (1 − 0.25)) = 7.2% + 1.8% = 9.0%. Any project with an expected return above 9% creates value; projects below 9% destroy value.
Source: Damodaran Online — WACC