What does a company’s weighted average cost of capital (WACC) represent?

Expert Solution

The weighted average cost of capital (WACC) is the cost of raising capital, with the weights representing the proportion of each source of financing that is used. It is used as a discount rate in net present value calculation. The target WACC is used to setting a capital structure strategy and evaluate a project that it is used as a discount rate in evaluation of the new projects of the company and company’s cost of capital depends on its riskiness. If the company decides to invest in a higher-risk project then its WACC should be higher.

Formula for the calculation of weighted average cost of capital (WACC) is

WACC = (E/ E+D+P) * re + (D/ E+D+P) * (1-t) * rd + (P/ E+D+P) * rp

Where, re is the cost of equity

And rd is the cost of debt

And rp is the cost of preferred stock

E is the value of common equity

D is the value of debt

P is the value of preferred stock

And t is the applicable tax rate

jeff jeffy answered 1 year ago

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