The cost of capital represents the weighted average cost of all sources of long-term financing to...

The cost of capital represents the weighted average cost of all sources of long-term financing to the firm, is normally the discount rate to use in analyzing an investment, is based on the valuation techniques from the previous chapter and is applied to bonds, preferred stock and common stock.

What does this mean?

Expert Solution

WACC is calculated using below formula

WACC = (We* Re) + (Wp * Rp) + (Wd * Rd) (1 - t)

Where,

Equity portion (We)

Preference share portion (Wp)

Debt portion (Wd)

Cost of equity (Re)

Cost of preference share

Cost of debt (Rd)

Tax rate (t)

While evaluating the project the WACC used as discount rate, all the inflow from the project is discounted using WACC.

The decision rule is the return from the project should always be greater than WACC. Otherwise the project will be result in losses.

jeff jeffy answered 20 hours ago

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