Question

Why does it make sense to use the Weighted Average Cost of Capital as the minimum required rate of return to analyze a company’s investment opportunities?

Answer 1

WACC - Weighted Average Cost of Capital

It is the best source to measure a company's performance. Basis this as one of the factors, potential investment in it's stocks, uptaking of a new project for a company can be decided. The higher the cost of capital ie The WACC, the more riskier it gets

In comparison to it's averae return, investors can decide whether to invest in the company's stock or not. If the firm produces a 15% ROI and has a WACC of 10%, investors earn 5% on every $1 spent and so on.

Formula for WACC considers Equity, Debt, Tax rate etc.

WACC = E/V*Re + D/V*Rd*(1-Tc)

E = EQUITY, D= DEBT, V =E+D

Re= Rate of Equity, Rd= Rate of Debt

Tc= Corporate tax rate