Question

What do we mean by a corporation's cost of capital and how does the Weighted Average Cost of Capital affect the discount rate a corporation uses to evaluate an investment

Answer 1

A corporation's cost of capital is the cost incurred by the corporation to raise funds (debt and equity).It is used for evaluation of various investments proposals.

The weighted average cost of capital is the sum of the products of the weight of a component with its cost.WACC =cost of debt *weight of debt +cost of common stock * weight of equity +cost of preferred stock * weight of preferred stock.coporations raise their funds through debt and equity .The funds are put to various uses and the cashflows that they generate are then evaluated by using the Weighted average cost of capital(WACC) as the discount rate.WACC is also used for internal purposes like evaluating mergers ,replacement projects etc.WACC is used by external investors to determine wether its worth investing in the company.