When to use weighted average cost of capital?

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How is the weighted average cost of capital calculated and in what situations is the weighted average cost of capital (WACC) used? What application does WACC have?

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score 0 · Answer 1 · 2012-12-02T21:37:30+00:00

You use the weighted average cost of capital to assess whether a project is worth undertaking. WACC basically gives you an average cost of borrowing money from either debt or from equity. If you want to assess, whether a project is worthwhile, you will need to see if the return (lets say that you will get your money back plus a 10%) is higher than the cost that you incur to borrow the money necessary for the investment (WACC).

If WACC is higher than the return of the project, then you spend more to find the money to invest than the actually return that this investment will give you.

score 0 · Answer 2 · 2013-05-07T23:29:31+00:00

WACC or the weighted average cost of capital is used for investment appraisals and valuations (among other things). For example, if you want to see if a project is worthwhile, you need to determine a rate that you will use to discount your cash flows. WACC is good rate to use since it reflects the cost you have to raise capital.