Weighted Average Cost of Capital (WACC)

WACC represents the minimum return a company must earn on its assets to satisfy both its debt holders and equity investors. It's calculated by weighting the cost of each funding source (debt, equity) by its proportion in the capital structure.

The formula is: WACC = (E/V × Re) + (D/V × Rd × (1-T)), where E is equity value, D is debt value, V is total value, Re is cost of equity, Rd is cost of debt, and T is the tax rate.

WACC serves as the discount rate in DCF valuations and the hurdle rate for capital allocation decisions. A company that consistently earns returns above its WACC is creating value; one earning below is destroying it.

The cost of equity is typically estimated using the Capital Asset Pricing Model (CAPM), which factors in the risk-free rate, equity risk premium, and company-specific beta. The cost of debt is simpler — it's the effective interest rate on borrowings, adjusted for the tax shield.