WACC is the rate that shows how a business funds itself. Or used in the evaluation of investment projects. It stands for "Weighted Average Cost of Capital". It is briefly indicated by WACC.
WACC is used to evaluate investment projects and to calculate the value of firms.
Since it will be easier to explain the WACC calculation on the example, we want to proceed with an example.
Let the financial status of a business be as follows:
• The sum of short-term debts is $ 10,000,
• Short-term debt interest rate is 12%,
• The sum of long-term debts is $ 20,000,
• Long-term debt interest rate is 10%,
• Equity total is $ 7,000,
• Equity cost is 18%,
• Let the tax rate be 20%.
In this case WACC = (10,000 / 37,000) * 0.12 * (1-0,20) + (20,000 / 37,000) * 0.10 * (1-0,20) + (7,000 / 37,000) * 0.18
WACC = 10.32%.
To explain the formula, the debts cover all of the debts in the liability part in the balance sheet.
The cost of debts is what the average interest rate is for all debts.
Equity is known equities.
If the cost of equity (cost of equity) = Risk-free return + Beta (sector) x Beta (country) x (Market return - Risk-free return) can be calculated with the formula.
The tax rate is also the tax that businesses are subject to.
In the example above, the value for WACC was 10.32%. Certainly there will be a cash flow statement for an investment with these values. If the calculated value is greater than 10.32% when the net cash flow and the internal rate of return (IRR) of the project is calculated over the years, this project seems financially reasonable. But it would be useful to do different financial studies rather than making decisions with WACC alone.