Cost of Capital Analysis: WACC Investors Should Know

Before deciding to invest in any project, the key question to ask is: Is the expected return truly worth the risk? And importantly, does it outweigh the cost of raising capital?

Many investors tend to focus only on the returns, overlooking the “cost” of that capital itself. This is a major mistake that can turn investments into losses. Therefore, understanding WACC is crucial for making smart decisions.

What is WACC and Why Is It Important?

WACC stands for Weighted Average Cost of Capital. In short, it is the average cost a company must pay to raise funds to run its business.

Simply put: If you need 10 million baht, you might borrow 6 million from a bank (pay interest), and ask the owners to invest 4 million (expect a return). The WACC is the average cost you pay from these two sources combined.

Why is it important? Because if the project’s return exceeds WACC, it indicates the investment is worthwhile. If it’s less, then it’s not worth it. That’s the key point.

Where Does the Capital Come From? The Two Main Sources to Know

WACC includes costs from two main components:

###1. Cost of Debt(

Cost of Debt is the expense of borrowing money, i.e., the interest rate the company pays to banks or financial institutions. This is money the company must pay without options.

Example: A company borrows 100 million baht at an interest rate of 7% per year, so it pays 7 million baht in interest annually. That is the Cost of Debt.

But an important point: this interest can be tax-deductible, so the actual cost is lower.

)2. Cost of Equity###

Cost of Equity is the return that shareholders expect to receive. It is not cash paid out but the return they require.

Why? Because shareholders bear more risk (if the company fails, they lose everything). Therefore, they demand a higher return than the interest on debt.

The WACC Formula You Need to Know

When capital comes from two sources, the calculation formula is:

WACC = (D/V) × Rd × (1 - Tc) + (E/V) × Re

Breaking down:

• D/V = proportion of debt in total capital
• Rd = Cost of Debt (interest rate)
• Tc = corporate tax rate
• E/V = proportion of equity in total capital
• Re = Cost of Equity (expected return)

Note that interest is multiplied by (1 - Tc). This tax shield means higher tax rates lower the effective borrowing cost.

Real-World Calculation Example

Let’s consider company XYZ:

Capital structure:

• Debt: 100 million baht (60% of total)
• Equity: 160 million baht (40% of total)

Other info:

• Cost of Debt: 7% per year
• Tax rate: 20%
• Cost of Equity: 15% (shareholders expect)

Calculations:

• D/V = 100 ÷ 260 ≈ 0.385
• E/V = 160 ÷ 260 ≈ 0.615

Plug into the formula:

WACC = (0.385 × 0.07 × 0.8) + (0.615 × 0.15)

WACC = 0.0215 + 0.0923

WACC ≈ 11.38%

Interpretation: Company XYZ has an average capital cost of 11.38%.

Conclusion: If this project yields a return of 15%, which is higher than 11.38%, it indicates the project is worth investing in.

What WACC Value Is Considered Good?

The lower, the better — that’s the simple principle.

Reasons:

• Lower WACC = lower capital costs = higher profit potential
• Higher WACC = expensive capital = need higher returns to be worthwhile

But “how low” depends on:

• Industry (tech companies often have higher WACC than traditional industries)
• Risk level
• Economic conditions

Simple rule: Expected return > WACC = investable

Expected return < WACC = do not invest

The Optimal Capital Structure

Companies should find a balance point that:

1. Minimizes WACC — reduces the cost of raising funds
2. Maximizes shareholder value — benefits shareholders the most

Options:

• Use only owner’s equity → WACC is high (owners bear more risk)
• Take on debt up to a certain level → WACC decreases due to lower interest costs and tax benefits
• Mix appropriately → WACC reaches an optimal level

Caution: WACC Is Not a Perfect Solution

( 1. Does not account for future changes

WACC is calculated based on current data, but interest rates, risk, and owner expectations can change. You need to update WACC regularly.

) 2. Ignores risk

WACC does not tell you how risky the project is. A project with a good WACC but high risk remains a poor investment.

3. Complex calculations

Requires up-to-date data; missing or incorrect info can lead to wrong conclusions.

4. Only an estimate

No WACC calculation is 100% accurate; results can vary based on assumptions.

How to Use WACC Effectively

1. Don’t rely solely on WACC

Use together with NPV ###Net Present Value### and IRR (Internal Rate of Return) to get a comprehensive view.

( 2. Keep it updated

Every quarter or whenever there are major changes in capital structure or market conditions. Up or down?

) 3. Consider risk separately

Use WACC as a starting point, but also evaluate risk factors and worst-case scenarios.

4. Compare with industry peers

Compare your company’s WACC with competitors. If higher, it could be a warning sign.

Summary

WACC is a key indicator that helps determine whether an investment is worthwhile. Knowing the Weighted Average Cost of Capital means understanding the true cost of the company’s funds.

But don’t rely solely on numbers. Use WACC as one tool among risk analysis, industry research, and market monitoring to make truly smart investment decisions.