What does WACC stand for in finance?

WACC stands for Weighted Average Cost of Capital, which is a critical concept in finance used to determine a firm's cost of capital from different sources, such as equity and debt. It provides a weighted average based on the proportion of each source of capital in the overall capital structure. This measure is vital for assessing investment opportunities and making decisions about capital expenditures, as it reflects the minimum return that a company must earn on its existing assets to satisfy its investors or creditors.

Calculating WACC involves determining the costs associated with equity and debt financing. The cost of equity is typically estimated using models such as the Capital Asset Pricing Model (CAPM), while the cost of debt is derived from the yield on existing debt or the rate at which the company can issue new debt. The proportional weights of equity and debt are based on their market values relative to the total capital.

Understanding WACC is essential for numerous financial analyses, including discounted cash flow (DCF) valuations, project evaluations, and corporate finance strategies. It serves as a benchmark against which investment returns are measured, ensuring that the capital raised is effectively utilized to generate adequate returns that exceed the cost of that capital.