Definition of ''Weighted Average Cost of Capital - WACC''
A calculation of a firm''s cost of capital where each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and another long-term debt - are involved in a WACC calculation. All else equal, the ''Weighted Average Cost Of Capital'' that is abbreviated as WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk.
The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:
WACC = (E/V * Re) + (D/V * Rd) * (1-Tc)
Re stands for cost of equity
Rd stands for cost of debt
E stands for market value of the firm''s equity
D stands for market value of the firm''s debt
V stands for E + D
E/V stands for percentage of financing that is equity
D/V stands for percentage of financing that is debt
Tc stands for corporate tax rate
Businesses frequently discount cash flows at WACC to determine the Net Present Value (NPV) of a project, using the formula:
NPV = Present Value (PV) of the Cash Flows discounted at WACC.