WACC

The weighted cost of capital (WACC) = Weighted Cost of each Component of Capital used by the Company.

Example:

If a company has the following financial structure its weighted cost of capital is 10.94% p.a.

Shareholder funds (including reserves): 3,756,775 (80.96% book weight. After tax costs 12%).
Long term loans 750,000 (16.16% book weight. After tax cost 6.5%).
Short term loans 133,500 (2.88% book weight. After tax cost (5.95%).

Then weighted cost of capital = 0.8096x0.12 + 0.1616x0.065 + 0.0288x0.0595 = 10.94% p.a.

There has been considerable debate over many years how the cost of equity can be determined. One generally accepted definition is:

The overall cost of equity to the company is the overall rate of return it must promise to deliver to its investor shareholders to persuade them to invest.

The most generally accepted equation that calculates a firm's cost of capital is the Capital Asset Pricing Model which incorporates a company's beta value.

A really successful company is one in which their ROIC exceeds WACC.

If the business has divisions, business units or single products where the ROIC is less than WACC, these activities are destroying shareholder value and should be corrected or eliminated.

If ROIC = WACC, the reason is that growth almost always requires additional investment, which has to be funded at the WACC rate. Extra profits however need to be earned at the ROIC rate for shareholder value to increase. Where these two values are equal, they cancel each other out and no advantage has been gained.

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WACC