Question

What is the definition of WACC and Cost of Capital?

Could you explain in easy English, please?

And, what is the relationship between WACC and Cost of Capital?

Answer 1

WACC, also known as weighted average cost of capital refers to the average after-tax cost of a firm's numerous sources of capital used to finance the firm. It is rate which a firm is expected to pay on average to all its stock holders for financing its assets

The cost of capital refers to the cost of a firm's funds i.e. minimum rate of return which a company must receive before generating value. It is required rate of return on a portfolio firm's existing securities for an investor.

Relationship: WACC is computation of the cost of capital of a firm wherein each category of capital is proportionately weighted. In calculation of WACC all capital sources are included such as preferred stock, common stock, bonds and any other long-term debt -All else equal, the firm's WACC increases when beta and rate of return on equity rises, as a rise in WACC notes a fall in valuation and a higher risk