meaning, calculation and significance of Weighted Average Cost of Capital (WACC) or Overall Cost of Capital
WACC denotes the Weighted Average Cost of Capital. It is also known as Overall Cost of Capital. As the name suggest, it is computed by reference to the proportion of each element of capital as weights. WACC is the expected average future cost of finance over the long run of firm.
Weighted Cost of Capital of Overall Cost of Capital represented symbolically by Ko
WACC = Sum of (Cost of each Capital Element × Proportion or percentage or weight of Capital)
The calculation of Weighted Average Cost of Capital or Overall Cost of Capital involves the following steps:-
- Determine the cost of each source of capital separately i.e. Cost of Equity Capital, Cost of Debt, Cost of Preference Capital, Cost of Retained Earning, Cost of Loan, Cost of any other finance.
- Determine the weight of each source of capital.
- Multiplying the cost of each of the source by appropriate weights. and
- Dividing the total weighted cost by total weight.