Weighted average cost of capital

The blended return that lenders and shareholders together require, weighted by how much of the funding each provides. It is the hurdle rate a business has to clear and the discount rate for an enterprise cash flow.

A company funded 70% by equity at a 13.5% cost and 30% by debt at 9% before tax, at a 25% tax rate, has a weighted average cost of capital of 11.48%.

Three details decide whether the number is usable. Weights should be market values rather than book values, because that is what an investor could actually buy today. The cost of debt is taken after tax, since interest is deductible. And the cost of equity comes from a model rather than from a survey, most often the capital asset pricing model, with all the imprecision that implies.

The output looks precise and is not. A weighted average cost of capital quoted to two decimal places carries an honest error of one or two percentage points, which is why sensible valuations run a range rather than a point.

Round it to the nearest half percent and move on.