Last January a posted a blog entry about EBITDA, explaining its meaning. Now, it’s the turn for WACC (Weighted average cost of capital) within finance. Finance is for me one of the more interesting MBA subjects in this second period.
WACC is used in finance to measure a firm’s cost of capital. It’s used by many companies as a discount rate for financed projects. Corporations raise money from two main sources: equity (money from the shareholders) and debt (bank loans). The WACC takes account the relative weights of each component of the capital structure and presents the expected cost of new capital for a firm.
The optimal financial structure of a firm would be the one that minimize the WACC, that way, the firm’s EV (Enterprise Value) in the market grows. Sometimes it could be better to increase the level of the debt instead of the equity. Another point to consider is its effect in market competition. Say you have two companies in the same field and with different WACCs. The one with lower WACC would be more competitive as future external investments (cash-flows) discounted with lower WACC make them more attractive (Investment’s Actual Value is bigger) than those discounted with a bigger WACC value.
WACC is used in finance to measure a firm’s cost of capital. It’s used by many companies as a discount rate for financed projects. Corporations raise money from two main sources: equity (money from the shareholders) and debt (bank loans). The WACC takes account the relative weights of each component of the capital structure and presents the expected cost of new capital for a firm.
The optimal financial structure of a firm would be the one that minimize the WACC, that way, the firm’s EV (Enterprise Value) in the market grows. Sometimes it could be better to increase the level of the debt instead of the equity. Another point to consider is its effect in market competition. Say you have two companies in the same field and with different WACCs. The one with lower WACC would be more competitive as future external investments (cash-flows) discounted with lower WACC make them more attractive (Investment’s Actual Value is bigger) than those discounted with a bigger WACC value.
Did you alreay know that? Not me to be honest... :-)
Thanks and smile,
dk
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