From the course: Managerial Finance Foundations
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Weighted average cost of capital (WACC)
From the course: Managerial Finance Foundations
Weighted average cost of capital (WACC)
- We are now ready to talk about the important topic of the weighted average cost of capital, or the WACC. 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. The cost of borrowing is just the interest rate on the loans. The cost of equity investment is the return that investors need to 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 two costs of those two sources of financing. Now, total financing in this simple example is $200 million, a $100 million in borrowing and $100 million in equity investment. Identifying the cost of borrowing is easy. The starting point is the interest rate on the loans. Let's say that this interest rate is…
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