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Definition: Weighted Average Cost of Capital is the average rate (percentage) a firm has to pay its various security holders to finance its business, operations and growth and pay.
WACC is used as the minimum return a company must earn when deciding on certain investments, strategies, projects or purchases.
Example:
- Total market value of debt = €800 million, of which market value of debt = €250 million and market value of equity = €550 million
- Cost of Debt = 7%
- Corporate Tax Rate = 36%
- Cost of Equity is 14%
Calculation WACC = ( 250/800 * 7% * (1 - 36%) ) + ( 550/800 * 14% ) = 11.01%
This means any investment should have a minimal rate of return of 11.01% to make it worthwhile.