Weighted Average Cost of Capital

The Weighted Average Cost of Capital or WACC is a financial metric used to measure the average rate that a company pays to finance its assets through various sources like debt and equity.

It is the average interest rate or return a company must pay to all its investors and creditors.

Companies can raise funds through debt, such as loans and bonds, or through equity, by selling stocks.

Both types of financing have costs such as interest payments for debt and dividends or expected returns for equity holders.

WACC considers how much of each type of financing, debt or equity, a company uses and assigns weights to it.

Consider Pixel Corporation as an example.

It primarily funds itself through equity, so the cost of equity will be given a higher weight in calculating its overall cost of capital.

This method gives a single percentage representing the corporation's total cost of raising funds.

WACC is crucial because it is used by management to make decisions about investments and projects.

It acts as a benchmark rate that a project must exceed in its returns to be considered viable for investment.