Weighted Average Cost of Capital1
In Chapter 20, we identified components of a company's capital structure. To estimate the weighted cost for all of the company's overall capital, we blend their costs together to derive the company's weighted average cost of capital (WACC), often called the overall cost of capital. In other words, we want to estimate the weighted cost for all of the company's invested capital. This requires a discussion of the appropriate amount of debt and equity in the capital structure and how much value, if any, the debt adds to the value of the providers of equity capital because of the interest tax shield that we discuss later in this chapter.
The most common assumptions made by analysts are that (1) the market value of debt capital equals its face value ...