Companies don’t get to use the money they raise from investors for free. The cost of capital, or weighted average cost of capital, is what a company must pay for the funds. Measuring cost of capital matters because a firm that doesn’t produce a return greater than the cost of capital may not be able to generate enough money to grow.

## Weighted Average Cost of Capital

To calculate cost of capital, first determine the total capital invested, which equals the market value of equity plus the firm’s total debt. The formula for cost of capital is equity as a percentage of total capital multiplied by the cost of equity, plus debt as a percentage of total capital multiplied by the cost of debt.

## WACC Example

Suppose equity is 40 percent of capital and the cost of equity is 15 percent. Debt is 60 percent of capital and the cost of debt is 10 percent. You have 40 percent times 15 percent plus 60 percent times 10 percent. This works out to a cost of capital of 12 percent of total capital invested.