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Weighted Average Cost of Capital (WACC): the WACC denotes the minimum ROCE that must be achieved by the company in order to satisfy its investors (shareholders and debtholders). It is important to understand that such WACC is largely independent from the capital structure of firm, but depends solely on the expected returns from the assets of the company and from the risk profile of these assets (no matter how the company’s equipments are financed, they should perform the same and bear the same operational risk). In order to determine the WACC, one can first determine the beta of the company’s assets (also called “unlevered beta”) and from there deduce the company’s WACC using a certain formula.

An alternative way to find out which WACC is applicable to the company is often given by the following: if we are assuming that a company is financed a % by debt and (100-a) % by equity (market values being considered here), that the (before tax) cost of debt is i % and the cost of equity is r %, then: WACC = a % x i % x (1-T_C) + (100-a) % x r %.

N.B 1.: if the company is not public, i.e. not floated on the stock market, then a market value cannot be determined but you will then use your own estimation of the market value of debt and equity, i.e. the price at which you estimate debt and equity could be sold. We will tackle the issue of business valuation (and thus of equity and debt valuation) later in this course.