Lesson 35 - Advanced Accounting Course

Lesson 35: Cost of Capital – WACC and Its Applications

💡 What is Cost of Capital?

The cost of capital is the rate of return a company must earn on its investments to satisfy investors and creditors.
It’s the minimum return the business needs to generate to stay valuable and attractive.

Think of it as the “hurdle rate” 🏃 a project must beat to be worth the investment.

📊 Two Main Sources of Capital

But since most companies use both, we use a blended cost called WACC.

🧮 What is WACC?

WACC stands for Weighted Average Cost of Capital.
It calculates a company’s average cost of raising money, considering both debt and equity.

🧪 WACC Formula

Where: 

💡 Note: Interest is tax-deductible, which is why we multiply debt by (1 - T).

🧠 Why WACC Matters

🎯 Example: WACC in Action

A company has:

• $400,000 in equity
  
  

• $600,000 in debt
  
  

• Cost of equity (Re) = 10%
  
  

• Cost of debt (Rd) = 5%
  
  

• Tax rate (T) = 30%

📌 This means the company needs to earn at least 6.1% on new investments to keep its value.

📘 Recap