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How WACC Can Affect a Company’s Appeal to Bondholders and Shareholders

Article Quant Q&A · Author: kinkajou
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Summary

The document explains that weighted average cost of capital represents a company’s average financing cost, so a lower WACC is generally preferable from the company’s perspective. It then considers why investors may view a higher WACC differently depending on whether they hold the company’s bonds or shares.

For bondholders, higher borrowing costs can mean greater bond returns, but may also signal heavier debt and greater risk. For shareholders, leverage may support expansion, while high debt costs can leave less profit for equity holders after debt obligations are met. The note emphasizes that bondholders have priority over shareholders in payment. It offers qualitative intuition rather than a valuation method, and gives no basis for concluding that a particular WACC, such as the stated example, makes a company attractive. The effect depends on the firm’s financing mix, risk, and ability to earn returns on borrowed capital.

Key ideas

  • WACC summarizes the weighted cost of a company’s capital.
  • A lower WACC reduces the company’s average financing cost.
  • Higher borrowing costs can benefit bondholders while also indicating greater company risk.
  • Debt may fund growth, but interest and repayment obligations take priority over shareholder claims.

Tags

EquitiesFixed incomeRisk management
Full text
# How to use WACC for investment?


# How to use WACC for investment?












How can I use the value of WACC(weighted average cost of capital)? I have calculated the WACC of company to be 7%. What if the company had a smaller or bigger WACC? Which one would attract investment?

## Answer by Rime (score 3, accepted)

https://quant.stackexchange.com/a/15940

WACC is the weighted average cost of capital therefore from the business's standpoint, they would want to have a lower WACC because it is an average of the % cost of capital. From an investor's standpoint: it can be mixed. For a bondholder, they would want WACC to be a bit high but not by too much. For example, a higher WACC may mean the company is paying a higher % on the bonds. A higher WACC may sometimes mean the company has too much debt & therefore require a higher return on the bonds since it is now a bit risky. As the bondholder, a shareholders view may be mixed. A higher WACC may mean leverage for the company to expand so it may be attractive but if it is too high the profits the company makes will be used to pay off debt hence the $k-g$ in Gordon's Growth Model. But remember that bondholders get paid prior to shareholders!

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.