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What is meant by Weighted Average Cost of Capital (WACC)?

a. What is meant by Weighted Average Cost of Capital (WACC)?

b. What are the components of WACC?

c. Why is WACC a more appropriate discount rate when doing capital budgeting?

d. What is the impact on WACC when an organization needs to raise long term capital?

Solution Preview

a. Overall cost of capital derived by weighting the respective costs of different parts of a company's capital structure by their proportions. All capital sources are included in the calculation of WACC.

WACC is calculated by multiplying the cost of each capital component by its proportional weight and then adding every component.

WACC = E/V*Re + D/V * Rd* (1-Tc)

Where
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + ...

Solution Summary

This solution of 377 words defines overall cost of capital and Weighted Average Cost of Capital (WACC). It details the components in WACC and describes the impacts and conditions of the ratio in capital budgeting and long-term capital.

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