Weighted average cost of capital
The rate of return that a business – regulated, or unregulated – expects to earn represents the minimum return required to retain the existing financing of the capital invested, and to attract new financing for new investment. It is typically measured by reference to the current cost of financing the business. As most businesses are funded by a combination of equity and debt, the
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Weighted average cost of capital
The rate of return that a business – regulated, or unregulated – expects to earn represents the minimum return required to retain the existing financing of the capital invested, and to attract new financing for new investment. It is typically measured by reference to the current cost of financing the business. As most businesses are funded by a combination of equity and debt, the
rate of return is typically measured as an average of the cost of equity and the cost of debt, each cost being weighted, as appropriate, by the contribution of equity or debt to total financing.

The rate of return is measured as a WACC.

The cost of equity used to finance a business is usually expressed as a nominal rate after allowance for tax. The cost of debt is usually expressed as a before-tax nominal rate. In consequence, provided the proper adjustments are made, the WACC can be expressed in either post-tax or pre-tax terms.

Observed costs of equity and debt are nominal costs. They incorporate current expectations of inflation. In some applications of the rate of return measured as a WACC, actual financial outcomes are important, and nominal costs are appropriate. In other applications, the focus is on change in the value of real goods and services, abstracting from changes in the general level of prices. In these applications, real costs of equity and debt must be used. A WACC may
therefore be expressed in either nominal or real terms.