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WACC (Weighted Average Cost of Capital)
Definition
WACC is the average rate of return a company must earn on its investments to satisfy all of its stakeholders, including shareholders and debt holders.
Explanation
WACC represents the blended cost of a company's capital structure, including equity and debt. It is calculated by weighting the cost of equity and the after-tax cost of debt by their respective proportions in the capital structure.
WACC is used as the discount rate in DCF valuation and as a hurdle rate for investment decisions. A company should only invest in projects that generate returns above its WACC, as lower returns would destroy shareholder value.
Example
A company with 60% equity (cost 12%) and 40% debt (cost 5%, tax rate 25%) has a WACC of: 0.6 × 12% + 0.4 × 5% × (1-0.25) = 8.7%.