Have you ever wondered why some investment projects are attractive while others are not worthwhile? Most people tend to look only at the expected returns, but that’s not enough to make an investment decision. We also need to consider the cost of capital used, which is where WACC comes into play.

WACC stands for Weighted Average Cost of Capital. It represents the average cost of the funds a company uses to operate. It tells us how much it costs to raise money for the business. Investors use this metric to assess whether an investment project is worthwhile or not.

WACC consists of two main components. The first is the cost of debt, which is the cost of borrowing from banks or financial institutions, expressed as the interest rate the company must pay. The second is the cost of equity, which is the return expected by shareholders from their investment.

The calculation of WACC uses the formula: WACC = (D/V)(Rd)(1-Tc) + (E/V)(Re), where D/V is the proportion of debt relative to total capital, Rd is the cost of debt, Tc is the corporate tax rate, E/V is the proportion of equity, and Re is the expected return.

Let’s look at a real example. Suppose Company XYZ has debt of 100 million baht (60%) and equity of 160 million baht (40%). The loan interest rate is 7% per year, the tax rate is 20%, and the expected return is 15%. Plugging these into the formula, the WACC is approximately 11.38%. Comparing this to the expected return (15%), since it’s higher than WACC, the project is considered attractive.

A lower WACC is better because it indicates the company has a lower cost of raising capital. However, other factors should also be considered, such as the industry the company operates in, project risk, and company policies. If the expected return exceeds WACC, the investment is worthwhile; if it’s lower, it’s not.

The best capital structure balances debt and equity to minimize WACC and maximize stock value. Using only equity results in a high WACC because shareholders bear all the risk. Adding debt lowers WACC because the cost of debt is lower, and interest payments are tax-deductible.

But be cautious—WACC doesn’t account for future changes, such as fluctuating interest rates or varying investment risks. Calculating WACC can be complex, and the resulting figure is only an estimate, not 100% precise.

To use WACC effectively, combine it with other financial metrics like NPV and IRR for a more comprehensive view. Also, regularly update the WACC calculation to reflect changes in interest rates, debt levels, and economic conditions.

In summary, WACC is a key financial indicator for investors, helping evaluate investment profitability and capital structure decisions. However, it should be used carefully, considering its limitations and alongside other factors to make the best investment decisions.