Weighted Average Cost of Capital, or WACC, is a metric used to measure a company’s financing ability.

Weighted Average Cost of Capital, or WACC, is a metric used to measure a company’s financing ability. WACC is a method of calculating a company’s cost of capital by taking the weighted average of the proportion of each type of capital relative to total capital. The calculation considers common equity, preferred equity, and debt. By multiplying each component by its respective weight in total capital and adding the results together, we obtain the weighted average cost of capital. As a financial metric used to assess a company’s financing ability, a higher WACC indicates higher financing costs and potentially greater investment risk. A lower WACC indicates lower financing costs and potentially lower investment risk. **Re:** The company’s cost of equity. This figure involves a degree of subjectivity. Investors typically determine it as a percentage based on their own analysis of the company, together with its historical rate of return. Alternatively, the cost of equity can be estimated using the CAPM model. **Rd:** The company’s cost of debt. This can be calculated by dividing the company’s total interest expense for the fiscal year by its total debt. **Tc:** The company’s corporate tax rate, which can be found in the financial reports of publicly traded companies. For the cost of equity, the Capital Asset Pricing Model, or CAPM, can be used for estimation. Its formula is: **Re = Rf + β(Rm − Rf)** Where: **Re:** Expected return on the stock **Rf:** Risk-free rate of return. The U.S. 10-year Treasury yield is generally used as the value for Rf. The current figure is 2.74% [Source]. **Rm:** Expected market return. The average return of the S&P 500 can be used for this calculation. For example: 10%. **β:** The stock’s systematic risk relative to the overall stock market. For example, Apple’s current beta is 1.22 [Source]. Under the CAPM model, the higher the beta, the higher the value of Re, indicating that investors expect a higher return from the stock. ## How to Calculate Apple’s Weighted Average Cost of Capital This section uses Apple’s Form 10-K, issued in September 2021, to demonstrate the calculation. The following data tables from Apple’s financial report are shown below: **Income statement:** **Balance sheet:** **Corporate tax rate:** **Interest expense:** The current stock price was obtained from Apple’s investor relations website: According to the data: | Item | Value | |---|---:| | Shares outstanding | 16,701,272,000 | | Stock price | $149.64 | | Total interest expense | $2,645 million | | Total debt | $287,912 million | | Corporate tax rate | 13.3% | Therefore: **Market capitalization, E = Shares outstanding × Stock price** = 16,701,272,000 × $149.64 = $2,499,178 million **Debt, D = $287,912 million** **Total capital, V = E + D** = $2,499,178 million + $287,912 million = $2,787,090 million = $2.787 trillion The cost of equity is calculated using the CAPM model: **Rf = 2.74%** **Average S&P 500 return: Rm = 10%** **Apple’s current beta: β = 1.22** Therefore: = 2.74% + 1.22(10% − 2.74%) = 11.60% **Cost of debt, Rd = Interest expense / Total debt** = $2,645 million / $287,912 million = 0.92% **Weighted Average Cost of Capital = Equity weight × Cost of equity + Debt weight × Cost of debt × (1 − Tax rate)** **WACC = (E/V × Re) + (D/V × Rd × (1 − Tc))** = ($2,499,178 M / $2,787,090 M × 11.60%) + ($287,912 M / $2,787,090 M × 0.92% × (1 – 13.30%)) = 10.40% + 0.08% = 10.48% ## What Is the Investment Significance of WACC? Investors typically use the weighted average cost of capital (WACC) to assess a company’s investment value. WACC represents the return required by investors for providing the company with capital, including debt and equity securities. A lower WACC indicates that the company has a lower cost of financing. A higher WACC indicates that the company has a higher cost of financing. When analyzing a company, it is generally useful to compare its WACC with its return on invested capital (ROIC) to assess the likelihood of generating returns on an investment. When ROIC is greater than WACC, the investment return exceeds the investment cost, indicating that the investment may generate a return. When ROIC is less than WACC, the company’s investment returns are lower than its average cost of capital, indicating that the investment may not generate a return and may represent a higher-risk investment. WACC can also be used as a discount rate to calculate the present value of future cash flows. The higher the WACC, the lower the present value of future cash flows and the lower the company’s implied future earnings potential. The lower the WACC, the higher the present value of future cash flows and the higher the company’s implied future earnings potential. Internally, companies also use WACC to assess the feasibility of undertaking specific projects or raising additional financing through debt or equity. A lower WACC generally means that projects or financing are less likely to face obstacles. A higher WACC generally means that projects or financing are more likely to face obstacles. ## What Are the Limitations of WACC? In practice, the inputs used to calculate WACC are significantly affected by market fluctuations. Factors such as U.S. Treasury yields and the company’s market capitalization can materially affect the calculated WACC. As a result, using WACC to evaluate a company’s cost of capital at different points in time may produce different results, which can in turn lead to different assessments of the company’s investment value. Therefore, WACC should be considered alongside other objective data when conducting financial analysis and valuation.