From the course: Finance Foundations
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Weighted-average cost of capital
- We are now ready to talk about the important topic of the weighted average cost of capital, or the WACC. As we have seen, a company's capital structure determines how costly it is to obtain external financing. Let's consider Lily's case three, where Lily gets half of her financing from lenders and half of her financing from investors. The weighted average cost of capital is then just the average of the cost of those two sources of financing. 5% for the lenders, 17% for the investors. The weighted average cost of capital is computed by just putting those two together with half weight on each one of them. The average is 11%. The weighted average cost of capital tells a company this: What does it cost us to get money? And then the company uses that WACC number to evaluate the attractiveness of various projects. We can compute the weighted average cost of capital in each one of the four Lily capital structure cases. 100% debt, 100% equity, 50/50 debt and equity, and 90/10 debt and…
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