What is the Difference Between Cost of Capital and WACC?
🆚 Go to Comparative Table 🆚The cost of capital and the weighted average cost of capital (WACC) are both concepts of finance that represent the cost of obtaining capital for a company. However, there are some differences between the two:
- Cost of Capital: This represents the minimum return necessary to justify a particular investment, such as purchasing new equipment or constructing a new building. It encompasses the cost of both equity and debt, weighted according to the company's preferred or existing capital structure.
- WACC: This is the most common method for calculating the cost of capital, and it equally averages a company's debt and equity from all sources. WACC is the average rate that a company expects to pay to finance its business, and it is commonly used as a hurdle rate against which companies and investors can gauge the attractiveness of investments.
In summary, the cost of capital represents the overall cost of obtaining capital for a company, while WACC is a specific method for calculating the cost of capital by considering the weighted average of the costs of debt and equity.
Comparative Table: Cost of Capital vs WACC
The cost of capital and the weighted average cost of capital (WACC) are both measures used to evaluate the cost of financing a company's operations. Here is a table highlighting the differences between the two:
| Cost of Capital | Weighted Average Cost of Capital (WACC) |
|---|---|
| Represents the minimum return necessary to justify a company's investment decisions. | Calculates the average cost of all capital sources, including debt and equity, proportionally weighted according to the company's capital structure. |
| Encompasses both equity and debt, but not weighted according to the company's capital structure. | Considers every type of debt and equity on the company's balance sheet, including common and preferred stock, bonds, and other forms of debt. |
| Used to evaluate the financial viability of a company's projected decisions. | Used to calculate the company's overall cost of capital, which is derived from the weighted average cost of all capital sources. |
| Formula: Not provided in the search results. | Formula: $$WACC = \frac{E}{V} \times Re + \frac{D}{V} \times Rd \times (1 - Tc)$$, where E = market value of equity, D = market value of debt, Re = cost of equity, Rd = cost of debt, Tc = corporate tax rate. |
In summary, the cost of capital is a broader concept that represents the minimum return required to justify a company's investment decisions, while WACC is a specific calculation that measures the average cost of all capital sources, weighted according to the company's capital structure.
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