Average Cost of Capital

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Definition: Average Cost of Capital

Average cost of capital comes under the purview of capital structure management. It refers to the minimum rate of return that the providers of capital expect the company to earn on its base of assets for them to continue to hold their credit in the company otherwise they are expected to move on and invest in some other company.

A company may have various sources of capital like debt, common stock, preferred stock etc. Therefore, average cost of capital is also called a weighted average cost of capital.

Mathematically it is expressed as:


WACC 

Where

r is the rate of return on each component of the capital

MV is the market value of that particular component of capital

Example

If a company has debt of Rs. 100 with a cost of debt of 5% and equity of Rs. 50 with a cost of equity of 15%.

WACC = ((100*5%)+(50*15%))/(150) = 7.66%



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