Weighted average cost of capital (WACC)

Definition

The Weighted Average Cost of Capital, commonly known as WACC, measures the average rate a company is expected to pay to finance its assets through a combination of debt and equity.

What it means

WACC represents the overall cost of raising capital for a business. It reflects the return required by both lenders and shareholders, weighted according to how much debt and equity the company uses in its capital structure.

Businesses, investors and analysts use WACC to evaluate investment decisions, company valuations and financial performance. A lower WACC generally indicates cheaper financing and lower perceived risk, while a higher WACC can suggest greater financing costs or business risk.

How it’s calculated

A simplified version of the formula is:

WACC = (E ÷ V × Cost of Equity) + (D ÷ V × Cost of Debt × (1 − Tax Rate))

Where:

• E = Market value of equity
• D = Market value of debt
• V = Total capital value (debt + equity)

The cost of debt is adjusted for tax because interest payments are often tax-deductible.

Example

A company finances its operations with:

• 70% equity at a cost of 9%
• 30% debt at a cost of 4%
• A corporate tax rate of 25%

Its weighted average cost of capital would be:

(0.70 × 9%) + (0.30 × 4% × (1 − 0.25))

= 6.3% + 0.9%

= 7.2%

This means the company’s average financing cost is 7.2%.

Why the Weighted Average Cost of Capital matters

• Helps businesses evaluate investment opportunities
• Used in discounted cash flow and company valuation models
• Indicates the minimum return needed to satisfy investors and lenders
• Supports decisions around financing and capital structure

Important to note

WACC is influenced by interest rates, market conditions, company risk and the balance between debt and equity financing.

In practice, the Weighted Average Cost of Capital is one of the most important metrics used to assess the true cost of funding a business and creating long-term shareholder value.