Weighted Average Cost of Capital (WACC) is the average rate a company is expected to pay to finance its assets, weighted by the proportion of each capital source. It represents the minimum return a company must earn to satisfy its investors and is used as the discount rate in Discounted Cash Flow (DCF) valuation.
WACC = (E/V × Re) + (D/V × Rd × (1 − Tc))
E = market value of equity, D = market value of debt, V = E + D (total firm value), Re = cost of equity, Rd = cost of debt (pre-tax), Tc = corporate tax rate. Debt gets a tax shield because interest is tax-deductible.
Example 1: Company: Equity value $600M (cost of equity 12%), Debt $400M (pre-tax cost 6%), Tax rate 25%
Result: WACC = 9.0%
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