Question

What is weighted average cost of capital how is it used and when is it not appropriate to use?

Answer 1

Weighted average cost of capital is the cost of capital which is weighted for debt and equity investments. In this, each category of capital is equally weighted and the cost of capital is calculated.

Let,

E = equity capital

D = Debt capital

Kd = cost of debt

T = tax rate

Ke = Cost of equity

Wd = D/(D+E)

We = E/(D+E)

WACC = Wd x Kd x (1-T) + We x Ke

One should always use WACC to determine whether we should or not invest in a project. This should be done in concurrence with other metrics. This is because various elements like Ke might show different values for different customers.