Which factor is included in calculating WACC?

The calculation of the Weighted Average Cost of Capital (WACC) involves both equity capital and debt capital, making the inclusion of both factors essential for determining the overall cost of capital for a company.

WACC represents the average rate that a company is expected to pay to finance its assets, calculated as a weighted average of the costs of the different components of its capital structure—equity and debt. The cost of equity reflects the return required by equity investors based on the risk of the investment, while the cost of debt represents the effective rate a company pays on its borrowed funds.

In the WACC formula, the proportion of equity and debt in the firm's capital structure is weighted by their respective costs. Additionally, since interest expenses on debt are tax-deductible, the after-tax cost of debt is also taken into consideration. This interplay between different sources of financing highlights the significance of both equity and debt in the calculation.

By using both equity and debt, WACC provides a more comprehensive measure of a company's cost of financing, crucial for evaluating investment projects and their potential returns. Thus, considering both factors ensures the WACC reflects the true cost of capital and aids in making informed financial decisions.