Weighted Average Cost of Capital (WACC)
Concept summarized by Sam Mishra, MBA (MIT Sloan)
WACC or Weighted Average Cost of Capital, is the expected rate of return on a portfolio of all the company’s securities.
Suppose a company has $3 billion in debt, borrowed at the rate of 8%
per annum; debt D = $3B. Further, suppose the company has $7 billion in
equity, trading in the public markets; and the company assumes a rate of return
of 15% per annum for its shareholders. Equity E = $7 B. So, the company value V can be calculated as follows:
V = D + E = 3 + 7 = $ 10 billion.
Now, WACC can be calculated as follows:
WACC = (D/V * debt interest rate) + (E/V * equity rate of
return) = (3/10 * 0.08) + (7/10 * 0.15) = 0.024 + 0.105 = 0.125 = 12.5%.
Also see Cost of Capital, and Hurdle Rate.
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