WACC, or Weighted Average Cost of Capital, is a financial metric used to measure the cost of capital to a firm. It is most usually used to provide a discount rate for a financed project, because the cost of financing the capital is a fairly logical price tag to put on the investment. WACC is used to determine the discount rate used in a DCF valuation model.
The two main sources a company has to raise money are equity and debt. WACC is the average of the costs of these two sources of finance, and gives each one the appropriate weighting.
Using a weighted average cost of capital allows the firm to calculate the exact cost of financing any project.
The formula for how to calculate WACC may seem complicated but in reality is fairly simple:
- (Percentage of finance that is equity x Cost of Equity) + (Percentage of finance that is debt x Cost of Debt) x (1 - Tax Rate)