Weighted Average Cost of Capital

Weighted Average Cost of Capital (WACC) represents a firm's average cost of financing from all capital sources, weighted according to their share in the capital structure. The formula for WACC is $\displaystyle WACC = \left(\frac{E}{V} \times Re\right) + \left(\frac{D}{V} \times Rd \times (1 - Tc)\right)$, where is the market value of equity, the market value of debt, the total capital (), the cost of equity, the cost of debt, and the corporate tax rate. The cost of equity is often estimated via the Capital Asset Pricing Model (CAPM): , with as the risk-free rate, the beta coefficient, and the expected market return. Cost of debt represents the effective interest rate on borrowed funds, adjusted for tax benefits since interest is tax-deductible. The weights reflect market value proportions of equity and debt, not book values. Including the tax shield lowers the after-tax cost of debt, thus reducing overall WACC. WACC is essential in management services for evaluating investment projects as the minimum acceptable return or hurdle rate. Firms optimize capital structure to minimize WACC, thereby maximizing firm value and shareholder wealth. Accurate WACC calculation supports proper firm valuation and strategic financing decisions, helping managers balance equity and debt to secure cost-effective funding.