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Weighted Average Cost of Capital

Weighted average cost of capital is the company’s average cost of all its capital finances, which could include bank loans, equity, and debentures in relation to what each capital factor relate to the total capital. The WACC is any important factor /rate in making corporate investment decisions. Consequently profitability index for a corporation requires that this rate should be as minimal as possible to help drive the most optimal profit margin. The weighting process as its basis on the existing capital market valuations, after tax costs and current yields.

WACC forms one of the most important corporate decisions in the financial management. (http://dictionary. bnet. com/definition/weighted+average+cost+of+capital. html) Generally, WACC has a lot of influence on capital budgeting and structure. It is basically a fundamental strategic management decision for an organization. Accordingly, WACC is allied to budgeting process through the identification analysis as well as selecting the most appropriate and viable long-term projects. Within the budget and capital structure framework, WACC is often used in determining the viability of spending money in capital investment by a corporation.

However, the use of the WACC in budgeting is compounded by various risks and uncertainties. Basically, this is occasioned by the corresponding inability of investment projects in meeting the viability criterion. Generally, the rate of spending on capital investment should have a less value than what is perceived by the WACC. However, capital investments could be unprofitable when the rate of returns on such capital spending is less than the level of WACC. (http://answers. yahoo. com/question/index? qid=20060731192731AAUH3oe) Economically, WACC represents the break-even point of the corporation’s profit-cost relationship.

Generally, like any other investment parameter, WACC seeks to measure the level of returns on investment perceived by capital spending on investment. Like any other investment, capital spending may be affected negatively by various market and political risks which may compromise their viability.

Reference

Weighted Average Cost of Capital. Retrieved on 1st May 2008 from http://dictionary. bnet. com/definition/weighted+average+cost+of+capital. html Why is WACC Important to an Organization? Retrieved on 1st May 2008 from http://answers. yahoo. com/question/index? qid=20060731192731AAUH3oe

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