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Importance of WACC

Understanding the weighted average cost of capital (WACC) is important, especially for companies that use both debt and equity financing. WACC shows the interest a company must pay for every amount financed and is used to calculate the net present value of projects and investments by applying it as the discount rate. A higher WACC means a company is riskier and less valuable, as the costs of financing are factored into the discount rate used to evaluate cash flows.

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399 views1 page

Importance of WACC

Understanding the weighted average cost of capital (WACC) is important, especially for companies that use both debt and equity financing. WACC shows the interest a company must pay for every amount financed and is used to calculate the net present value of projects and investments by applying it as the discount rate. A higher WACC means a company is riskier and less valuable, as the costs of financing are factored into the discount rate used to evaluate cash flows.

Uploaded by

ashraf187
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© Attribution Non-Commercial (BY-NC)
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Importance of WACC Understanding WACC is very important especially when the capital structure of a firm involves both debt

and equity financing. The WACC is important due to following reasons:-

WACC shows how much interest the company has to pay for every penny it finances. An increase in WACC notes a decrease in valuation and a higher risk as the WACC of a firm increases as the debt and rate of return on equity increases and vice versa. WACC is used to calculate the Net Present Value (NPV) which will allow the evaluation of projects or investment. The WACC is also used as an applicable discount rate at which to evaluate the projects. Since the costs of financing (receiving the loan, making interest payments and repaying principal) are never included as cash flows when estimating the cash flows to investment, thus cost of financing will be taken account of in the discount rate.

WACC shows the value of the firm or its earnings potential. Earning potential is maximized if WACC is minimized & vice versa.

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