The Weighted Average Cost of Capital (WACC) – A Story of Two Investors

In the heart of Mumbai’s financial district, Mehra Industries, a mid-sized manufacturing company, was looking to expand. Their CEO, Amit Mehra, knew that to build a new factory, he needed funding. But where should the money come from?

The Capital Hunt Begins

Amit had two options:

1. Borrow from the bank (Debt) 🔵 – The bank was offering a loan at 8% interest, but they needed collateral, and Amit would have to make regular payments.
2. Sell company shares (Equity) 🟢 – Investors were willing to buy a stake in Mehra Industries, but they expected at least a 12% return on their investment.

Amit sat in his office, sipping chai, thinking, "If I use both debt and equity, how do I calculate the actual cost of funding?"

Enter the Financial Analyst: Riya

That’s when Riya, Mehra Industries’ sharp financial analyst, stepped in.
“Sir, we need to calculate our Weighted Average Cost of Capital (WACC),” she said.

“What’s that?” Amit asked, intrigued.

Breaking Down WACC

Riya explained:
👉 Debt is cheaper than equity because the bank's interest rate (8%) is lower than what investors demand (12%).
👉 But we can't rely too much on debt—too much borrowing means high risk.
👉 The formula for WACC balances the cost of both sources of funding:

$$WACC = \left(\frac{D}{D+E} \times r_d \times (1 - T)\right) + \left(\frac{E}{D+E} \times r_e\right)$$

Where:

• $D$ = Debt
• $E$ = Equity
• $r_d$ = Cost of Debt (Interest Rate)
• $r_e$ = Cost of Equity (Return Expected by Investors)
• $T$ = Tax Rate

The Calculation

Mehra Industries had:

• ₹50 crore in debt (at 8% interest)
• ₹50 crore in equity (at 12% expected return)
• A tax rate of 30%

$$WACC = \left(\frac{50}{100} \times 8\% \times (1 - 0.30)\right) + \left(\frac{50}{100} \times 12\%\right)$$
$$WACC = (0.5 \times 5.6\%) + (0.5 \times 12\%)$$
$$WACC = 2.8\% + 6\% = 8.8\%$$

What This Means for Amit

Riya concluded, “This means our overall cost of capital is 8.8%. Any project we invest in must generate returns higher than 8.8% to be profitable.”

Amit smiled. “So, if our factory expansion gives us a return of 10%, we go ahead?”

“Exactly,” Riya nodded. “If it’s below 8.8%, we’d be losing money.”

The Decision

Armed with WACC, Amit decided to proceed with the factory expansion. The company carefully balanced debt and equity, ensuring their funding was cost-effective.

And that’s how understanding WACC helped a company make a multi-crore decision.

[Finance]