Weighted average cost of capital
Weighted Average Cost of Capital (WACC) represents company's blended cost of capital across all sources, including common shares, preferred shares, and debt.
WACC is calculated according to the formula:
WACC = (E/V x Re) + ((D/V x Rd) x (1 – T)),
E = market value of the firm’s equity
D = market value of the firm’s debt
V = equity + debt (total value)
Re = cost of equity (required rate of return)
Rd = cost of debt (yield to maturity on existing debt)
The company has two sources of capital: equity and debt. Each source of capital has its own value for the company. Creditors require to return the principal and interest, and shareholders want to get return on investment.
WACC is the interest rate, the minimum return that a company must earn on its existing capital to meet investor expectations. The higher the WACC value, the more revenue the company will have to generate to cover it.
The economic content of WACC is that the company makes investment decisions if the return on investment is not lower than the value of WACC.
The Ranks methodology uses the WACC Short Term Debt Cost, which is the company's marginal cost to issue new short-term debt. The indicator is analyzed in the Financial position block.
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