metrics explained

Weighted Average Cost of Capital vs return on invested capital: What's the Difference?

When it comes to making investment decisions, both public and private companies need to consider what their cost of capital is. The cost of capital is the minimum return that a company must earn on its investment projects to satisfy its shareholders. In other words, it is the required rate of return that a company must earn on its investments in order to maintain its current market value.

There are two main types of cost of capital: the weighted average cost of capital (WACC) and the return on invested capital (ROIC). Both measures have their own advantages and disadvantages, which will be discussed in detail below.

The weighted average cost of capital is the average of a company's cost of equity and cost of debt, weighted by their respective proportions of the company's total capital. The main advantage of using the WACC is that it takes into account the different risks associated with equity and debt financing. The disadvantage of using the WACC is that it is a long-term average and may not be representative of the company's current cost of capital.

The return on invested capital is the return that a company earns on its invested capital. The main advantage of using the ROIC is that it is a current measure of the company's cost of capital. The disadvantage of using the ROIC is that it does not take into account the different risks associated with equity and debt financing.

So, which measure is better? The answer depends on the specific situation. If a company is looking for a long-term average, then the WACC is a better measure. If a company is looking for a current measure, then the ROIC is a better measure.

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