Weighted Average Cost of Capital

The weighted average cost of capital (WACC) is a weighted average of the after-tax required rates of return on a company’s common stock, preferred stock, and long-term debt, where the weights are the fraction of each source of financing in the company’s target capital structure.

Formula

r_{WACC} = \displaystyle\frac{D}{D+E} \times r_D \times (1-t) + \displaystyle\frac{E}{D+E} \times r_E

where

  • r_{WACC} is the WACC
  • r_D is the before-tax marginal cost of debt
  • r_E is the cost of equity
  • D denotes the market value of the shareholders’ outstanding debt
  • E denotes the market value of the shareholders’ outstanding equity
  • t is the marginal tax rate

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