What is the weighted average cost of capital (WACC)?

The weighted average cost of capital (WACC) is fundamentally defined as the average rate of return a company is expected to pay its security holders, which includes both debt and equity holders, to finance its assets. This concept integrates the costs of equity and debt, adjusting them according to their respective proportions in the company's capital structure.

WACC is crucial for firms as it serves as a benchmark for assessing investment opportunities: if a project’s expected return exceeds the WACC, it is considered value-adding to the company. The calculation typically accounts for the cost of equity (which could include dividend expectations) and the after-tax cost of debt, both weighted by their respective shares in the overall capital structure. This holistic approach ensures a more accurate reflection of the cost of financing, making option B the correct definition of WACC, as it encompasses the expectations of all security holders, thereby providing insight into the overall cost of financing to support operations and growth.