Cost of Capital WACC CAPM
No investment comes for free; if the expected return from a project is lower than the cost paid to attract that capital, you create destruction, not growth.
The Weighted Average Cost of Capital (WACC) is the average invoice of the blend of debt and equity a company uses to finance its operations. When managers embark on a new project, the Internal Rate of Return (IRR) generated by this initiative must strictly exceed the WACC; otherwise, capital is eroded.
The equity cost leg of this equation is measured by the Capital Asset Pricing Model (CAPM). CAPM calculates the extra premium investors will demand on top of the risk-free rate, based on the company's volatility risk relative to the market (Beta). The cost of capital serves as a hurdle rate; only cash flows that can overcome this hurdle add genuine value to the company.
