WACC (Weighted Average Cost of Capital)
The average after-tax cost of all capital sources a company uses, weighted by each source's proportion of total capital.
What is WACC?
WACC (Weighted Average Cost of Capital) is the minimum required rate of return a company must earn on its investments to satisfy all capital providers — both debt holders and equity holders. It is calculated as: WACC = (E/V × Re) + (D/V × Rd × (1 − T)), where E is equity market value, D is debt market value, V is total capital (E + D), Re is cost of equity, Rd is pre-tax cost of debt, and T is the tax rate. The (1 − T) factor reflects the tax shield on interest expense. In discounted cash flow (DCF) analysis, WACC serves as the discount rate applied to free cash flows to arrive at enterprise value. A higher WACC means a company's cost of capital is higher, reducing the present value of future cash flows.
Example
A company has $600 million of equity (cost of equity = 10%) and $400 million of debt (pre-tax cost = 5%), giving a 60/40 equity/debt split on $1 billion total capital. With a 25% tax rate: WACC = (0.60 × 10%) + (0.40 × 5% × 0.75) = 6.0% + 1.5% = 7.5%. When valuing this company via DCF, an analyst discounts projected free cash flows at 7.5%. If the company earns returns above 7.5%, it is creating value; below 7.5%, it is destroying value.