UK Accounting Glossary
The Weight Average Cost of Capital is calculated as such: WACC = (proportion of loan capital * cost of loan capital) + (proportion of equity capital x cost of equity capital)
Weighted Average Cost Of Capital (WACC)
This is a means of calculating the average cost of a company’s different sources of Finance.
The weighted average cost of capital is calculated on the assumption that the company will maintain the same debt-equity ratio.
Managers should only use WACC as an appropriate discount rate for a project, if the project has a similar level of risk as the company.
The most problematic part of the calculation is making estimations as to the cost of equity.
In theory, a company is able to reduce it’s weighted average cost of capital by increasing the proportion of it’s debts. However, this could become problematic for shareholders, who may believe that higher debt levels will negatively impact the overall risk of their investment.
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This glossary post was last updated: 29th January 2019.