Question

1. What is the WACC and why it is important?

Answer 1

Weighted Average Cost of Capital (WACC)

Cost of capital is the minimum required rate of return expected from the investment. In simply WACC is rate of return from overall capital. After ascertaining specific cost of capital of each sources such as , cost of equity , cost of debt, cost of preference share etc. than find overall cost of capital of the firm. So that WACC is the cost of capital in which each category of capital proportionately weighted. WACC is mainly used for a discount rate.

Firms cost of capital is considered Weighted Average Cost of Capital. The WACC is the average rate of return that the firms expected to pay security holders like equity holders and others.

Importance of WACC :-

• Weighted Average Cost of Capital is appraising the financial performance of top management.
• It represent the investors opportunity cost of taking on the risk of putting money into a company.
• WACC shows how much interest the firm has to pay for every security holders.
• WACC used to calculate Net Present Value, it allow to evaluation of project or investment and used to appropriate discount rate to evaluate the project.
• WACC reflect what the firm needs to earn on a new investment.
• It help to show the value of the firm or earnings potential and the earnings potential is maximized through minimized WACC.
• It is a measure of Inter-Firm Comparison and find out Economic value Added (EVA).