WACC (Weighted Average Cost of Capital) is the average cost of all the capital a company uses. It measures the average return a company must provide to all its investors — both shareholders and creditors.
When calculating WACC, the cost of each capital source (equity cost, debt cost) is weighted by its proportion in the total capital structure.
The formula is: WACC = (E/V x Re) + (D/V x Rd x (1 - Tc)), where E is market value of equity, D is market value of debt, V is total capital (E+D), Re is cost of equity, Rd is cost of debt, and Tc is the corporate tax rate.
Companies use WACC to evaluate investment projects. If a project's expected return exceeds the WACC, it's expected to create value. WACC serves as a hurdle rate — the minimum return a project must deliver to be worthwhile.