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WACC (Weighted Average Cost of Capital)

Definition: The weighted average cost of capital is the cost associated with a firm's capital structure.  It's characterized by the following equation:

WACC = (E/V * Re) + (D/V * Rd)(1 - t)

E = Market value of the firm's equity
D = Market value of the firm's debt
V = Market value of the firm (E + D)
Re = Cost of equity
Rd = Cost of debt
T = corporate tax rate (typically 35%)

WACC's typically fall in the 6% to 15% range.

More Details: Companies are financed by a combination of debt and equity.  They then invest this money by putting it to use, whether it be in purchasing inventory or buying new plants.  There is a cost of using this capital (money isn't free) so they try to earn returns in excess of this cost.  The cost is referred to as the weighted average cost of capital (WACC).

 

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