What does the term "Weighted Average Cost of Capital" (WACC) refer to?

The term "Weighted Average Cost of Capital" (WACC) refers to the average rate of return a company pays to its security holders, making it a crucial metric in finance for assessing the cost of financing a company's operations through various sources, including equity and debt. WACC is calculated by multiplying the cost of each component of capital by its proportional weight in the overall capital structure and then summing those values. This reflects the risk and expected return required by investors, which directly impacts the valuation and investment decisions within a company.

When assessing the financial health and efficiency of a business, understanding WACC helps in evaluating whether the company can generate returns that exceed its cost of capital. A WACC lower than the company's return on invested capital indicates that it is creating value, while a higher WACC suggests that the company might be destroying value.

The other alternatives do not accurately embody the concept of WACC. Acquiring new customers relates to sales and marketing costs rather than capital costs. The total equity divided by total assets measures a different metric known as the equity ratio, and the average interest rate on a company’s loans relates specifically to debt cost rather than providing a comprehensive view of the overall cost of capital, as it does not include equity.