Weighted Average Cost Capital (WACC)

Formal

The total cost of borrowing money and the dividend return required by shareholders, combined into an average annual percentage rate. Often used as the minimum level of return needed from incremental (investment) spend - to cover the minimum requirements of the people who provided the funding in the first place. Eg a company runs its business with £1 Million loan at 5% and the shareholders provided £1 Million of share capital on which they require 10% return. WACC = 7.5%

Straight Talk

Let’s assume that you borrow money from a bank to buy your own house. This is low risk for them…so they charge you 5% interest per annum. Next assume that you have borrowed an identical amount of money from someone else to start your own business. They charge you 10% per annum because it’s a much riskier loan with little or no security. So - if you wanted to calculate the average cost of your own personal lending structure it will be 7.5% - the average of the 2 rates. It’s just the same for companies that have shares, loans and other types of finance.