Series 79 practice questioneasyWACC and Cost of Capital
The weighted average cost of capital (WACC) represents:
- AThe return required only by equity investors
- BThe cost of debt financing only
- CThe blended rate of return required by all providers of capital, weighted by their proportion in the capital structure✓ Correct answer
- DThe risk-free rate plus the market risk premium
Explanation
Why C — The blended rate of return required by all providers of capital, weighted by their proportion in the capital structure
WACC is the weighted average of the cost of equity and the after-tax cost of debt, weighted by their respective proportions in the company's capital structure. It represents the minimum return a company must earn on its existing asset base to satisfy all capital providers. WACC is used as the discount rate in enterprise DCF analysis because the cash flows being discounted (unlevered free cash flows) are available to both debt and equity holders.
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