Short definition: The weighted average cost of capital (WACC) is the average rate of return a company must earn on its existing assets to satisfy its investors.
Explanation: WACC represents the average cost of all the capital a company has raised, including debt and equity. It is calculated by weighting the cost of each capital component (debt and equity) by its proportional share of the company’s total capital structure.
Example: If a company has raised $1 million in debt with an interest rate of 5% and $2 million in equity with an expected return of 10%, its WACC would be 8.33% ((1/3 * 5%) + (2/3 * 10%)).
Additional information (optional): WACC is a crucial metric used in financial modeling and valuation, as it serves as the discount rate for calculating the present value of future cash flows. A higher WACC indicates a higher risk profile for a company, while a lower WACC suggests a lower risk profile.