10 stock analysis ratios used by the pros

Weighted Average Cost of Capital (WACC)

WACC is effectively the cost of a business’s assets. A company’s capital is usually funded by two components; equity and debt.

A business will have to compensate the holders of these assets which, in a nutshell, is the Weighted Average Cost of Capital.

Any activities or projects undertaken by the business must produce a return in excess of WACC to produce a profit.

Often overlooked by many investors, WACC is a basic measure of a business’s costs and therefore a key element in estimating the net present value (NPV) of a project or a business. WACC is taken from future cash flows to calculate NPV.

The higher the WACC, the more a company is required to make from operations leaving less room for error, therefore companies with a higher WACC are higher risk than those with lower WACC.

Formula:

WACC = (cost of equity x (market value of equity/market value of equity + market value of debt)) + ((cost of debt x (market value of debt/market value of equity + market value of debt)) x 1- Tax Rate)

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