WACC

In corporate finance, the weighted average cost of capital (WACC) is the average rate that a company is expected to pay to finance its assets. It represents the blended cost of equity, debt, and other securities, weighted by their shares of the firm’s capital structure, and is often used as a hurdle rate or discount rate in financial analysis.

The WACC is calculated as the sum of the costs of each component weighted by its market value share: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) + (P/V) * Rp. Here, E is the market value of equity, D is the market value of debt, P is the market value of any preferred stock, V is total market value (E + D + P), Re is the cost of equity, Rd is the cost of debt, Rp is the cost of preferred stock, and Tc is the corporate tax rate. The debt term includes the tax shield, hence the (1 - Tc) factor.

Costs are typically estimated as follows: Re can be determined using models such as the capital asset pricing model (CAPM): Re = Rf + beta * (Rm - Rf). Rd is the after-tax cost of new or existing debt, based on yields or spreads, while Rp is the cost of preferred stock. Inputs are usually expressed in market values to reflect current opportunity costs.

WACC is used as the discount rate in net present value calculations, to assess project and company valuations, and to gauge overall hurdle rates. It can be sensitive to input assumptions and may not capture project-specific risk or future changes in capital structure.

Example: if a firm uses 50% equity, 40% debt, and 10% preferred stock with Re = 8%, Rd = 4%, Rp = 6%, and Tc = 21%, then WACC ≈ 5.9%.