From the course: Foundations of Treasury Management
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Weighted average cost of capital (WACC)
From the course: Foundations of Treasury Management
Weighted average cost of capital (WACC)
- A company's weighted average cost of capital, or WACC, is used to evaluate the attractiveness of new projects. Cost of capital is the cost of obtaining external financing, which is a combination of the cost of borrowing and the cost of equity investment. Now, the cost of borrowing is just the interest rate on the loans. The cost of equity investment is the return that investors expect to encourage them to invest in a project. Let's consider a simple case in which a company gets half of its financing from lenders and half of its financing from investors. The weighted average cost of capital is then just the average of the cost of these two sources of financing. Total financing in this example is $200 million, 100 million in borrowing and 100 million in equity investment. Identifying the cost of borrowing is pretty easy. The starting point is the interest rate on the loans. Let's say that this interest rate is 5%. $100…
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