Advertisement

WACC

WACC stands for the weighted average cost of capital. It represents the rate of return a company must make on the money it has invested to stop investors putting their money elsewhere.

WACC stands for the weighted average cost of capital. It represents the rate of return a company must make on the money it has invested to stop investors putting their money elsewhere. In short, it is the company's cost of money.

To calculate it, you take the weighted average of the cost of borrowing money from banks or bondholders (debt) and shareholders (equity). The cost of debt is the interest rate charged by borrowers, less the company's tax rate (because interest charges reduce a company's taxable profits).

Advertisement - Article continues below

However, equity costs more than debt, because shareholders get paid last and so need to be paid more to reflect this. Exactly how much extra is subject to a lot of debate, and there is no right answer. It is affected both by how risky the underlying business is and how indebted it is.

Say a business is half-funded by debt at 5% and half-funded by equity at 10%. Its WACC will be (0.5x5%) + (0.5x10%) = 7.5%. WACC can be a better way to measure the ability of company managers than earnings per share (EPS). When interest rates are low, managers can boost EPS by funding the company with more debt, but may not earn a high enough return to compensate shareholders for the risks

Advertisement
Advertisement

Recommended

Visit/glossary/601570/real-exchange-rate
Glossary

Real exchange rate

The real exchange rate between two currencies combines the nominal exchange rate with the ratio of the price of goods or services in two different cou…
26 Jun 2020
Visit/glossary/esg-investing
Glossary

ESG investing

ESG stands for environmental, social and corporate governance, the areas in which good behaviour is particularly sought.
19 Jun 2020
Visit/glossary/601496/faang-stocks
Glossary

FAANG stocks

The acronym FAANG refers to Facebook, Amazon, Apple, Netflix and Google (Alphabet) – five American companies that have been among the top-performing s…
12 Jun 2020
Visit/glossary/technical-analysis
Glossary

Technical analysis

Technical analysts or 'chartists' attempt to predict future share price (or index) movements by looking at past movements.
5 Jun 2020

Most Popular

Visit/investments/property/601606/house-prices-crash-uk-property-prices-falling-where-next
Property

House price crash: UK property prices are falling – so where next?

With UK property prices falling for the first time in eight years, are we about to see a house price crash? John Stepek looks at what’s behind the sli…
2 Jul 2020
Visit/economy/inflation/601584/the-end-of-the-bond-bull-market-and-the-return-of-inflation
Inflation

The end of the bond bull market and the return of inflation

Central bank stimulus, surging post-lockdown demand and the end of the 40-year bond bull market. It all points to inflation, says John Stepek. Here’s …
30 Jun 2020
Visit/investments/stockmarkets/601611/nasdaq-all-time-high-markets-and-the-real-economy
Stockmarkets

How can markets hit new record highs when the economy is in such a mess?

Despite the world being in the midst of a global pandemic, America's Nasdaq stock index just hit an all-time high. And it's not the only index on a bu…
3 Jul 2020