Weighted Average Cost of Capital (WACC) is the company’s cost of capital which calculate from both debt and equity. It is the minimum required rate of return for the company before making any new investment. WACC averages the cost of company obtaining capital from different sources include common stock, preferred stock, bonds, and other long-term debt.

It is very important to know the cost of obtaining the capital in order to make the decision before investment. The company needs to invest in any project which generates a return more than the WACC.

## WACC Formula

$WACC = {Re*({E \over V})} + {Rd*({D \over V})* (1-TC)}$
• E = Market value of the firm’s equity
• D = Market value of the firm’s debt
• V = E+D
• Re = Cost of equity
• Rd = Cost of debt
• TC = Corporate tax rate

## WACC Assumption

• Capital Structure remains the same: We assume that the company’s capital structure will remain the same over time.
• Business risk remains the same: We assume that the business risk will remain the same over time even after accepting a new project. In reality, the risk will be change when company expands or invest in a new market.

The company uses WACC very often in daily operations. It helps management to build long-term investments. The advantage of using this tool can be found in the following:

• Easy to calculate: WACC calculation is very simple and straightforward. It does not require any complicated skill to analyze the formula. The data used in the calculation is also easy to find. We simply look at the company financial statement, and we will be able to get most of the required input.
• One for all: with only one ratio, we can apply it to all new projects or investments. It is fair to accept or reject the project when we compare them to one cost of capital.
• Quick decision making: WACC allows management to make quick decisions by comparing project profitability with WACC. As it is very easy to collect data and calculate, we will be able to get the result in a short time. The analysis of WACC also straightforward. As a result, it will save a lot of time and headaches.
• Merger and Acquisition: WACC is also used to support the merger and acquisition decision. It becomes basic to prepare financial statement.
• Replace Hurdle rate: WACC is the minimum return that company expects to get from the new investment. So it can be used to replace the hurdle rate for some companies. Even it is not exactly equal to the hurdle rate, but management can use it as the benchmark.