A business has its WACC of 10%, what does this number mean to a business ?

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BlackTom AI · Accepted Answer

First, let’s restate the scenario to anchor our thinking: the business has a weighted average cost of capital (WACC) of 10%, and we are asked what this number means for the business.
Option 1: 'The IRR of the business is likely to be less than 10%'. This is a misconception. WACC is a hurdle rate representing the minimum acceptable return adjusted for risk and financing costs. It does not imply that the Internal Rate of Return (IRR) of the business’s operations or all projects will be below 10%; some projects could exceed it while others fall short. The statement oversimplifies IRR behavior and conflates it with WACC.
Option 2: 'This is the maximum return that the business can produce'. This is incorrect. WACC does not cap returns; rather, it sets the threshold for acceptable project returns. Projects earning more than WACC add value; projects earning less destroy value. So WACC is not a ceiling on possible returns.
Option 3: 'This is the potential return that the business can produces'. This wording is vague and misleading. WACC is not a projection of potential returns across all projects. It is a cost of financing used as a benchmark for evaluating projects. It does not state what the business will or can achieve in terms of returns.
Option 4: 'The business will require at least 10% return from a project due to its cost of capital being 10%'. This option correctly reflects the core purpose of WACC: it represents the minimum acceptable return a project must earn to satisfy both debt and equity investors given the risk and financing mix. Projects should earn at least this rate to be value-enhancing, after adjusting for risk and opportunity cost. In other words, WACC acts as a hurdle rate for investment decisions, guiding which projects to undertake.

In summary, the first three options mischaracterize the role of WACC by misapplying or overgeneralizing its meaning, whereas the fourth option accurately captures the concept: WACC is the required minimum return on a project given the company’s cost of capital and risk profile.

A business has its WACC of 10%, what does this number mean to a business ?

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