When I was in the #marinecorps years ago, I didn’t put much thought into how companies financed operations. I’m pretty sure I thought it was all from a bank or internal cash. In reality there are many ways a company can finance their existing operations, new projects and inorganic growth opportunities like an acquisition. A company can borrow it from banks, VC investors, selling bonds or they can sell part ownership of the company through stocks (public or private). But getting money costs money, and that’s where WACC comes in.
WACC (Weighted Average Cost of Capital) is a way to figure out how much it costs a company to borrow money or pay back investors. It’s like the interest rate you pay on a loan. If a company wants to do something new, they use WACC to decide if it’s worth it. It’s also the most commonly used discount rate when looking at the PV of cash flows within a company in order to find Enterprise Value or a projected stock price.
Here are some things to know about WACC:
1. WACC helps companies decide if they should do new projects or investments.
2. It’s calculated using the cost of borrowing money (like a loan) and the cost of selling ownership (like stocks).
3. WACC only works if the company’s mix of borrowing and ownership stays the same.
4. It helps companies figure out how much future money is worth today.
5. The amount of WACC depends on the company and what kind of business it does.
Tomorrow we’ll work through the WACC formula piece by piece.