What is the difference between the WACC, r (required rate of return), and the cost of capital?

CFA Level II
#1

I know the question may seem simple, but I see these words sometimes I think they mean the same, and sometimes I think that they have different meanings. Can someone please help me out with these simple yet not so simple terms. Thanks

#2

WACC is the opportunity cost of capital that is used in the firm, weighted by capital type (i.e. debt vs. equity). r is the opportunity cost of capital that you invest in the firm. WACC is often used as a substitute for r. However, their pure definitions are different.

#3

WACC is the average of the costs of sources of financing, each of which is weighted by its respective use in the given situation. This is what you have. While r is a return which you expect or want to earn from your investment. Cost of capital is the same as WACC. In most situations, for eg., in expansion projects you would want your required rate of return to be either equal or more than WACC

#4

thank you

#5

All accurate descriptions. In essence, they are the same.

#6

Directly from the book:

"The required rate of return is the discount rate that investors should require given the riskiness of the project. This discount rate is frequently called the “opportunity cost of funds” or the “cost of capital.”

(Institute 8)

Institute, CFA. 2016 CFA Level I Volume 4 Corporate Finance and Portfolio Management. CFA Institute, 07/2015. VitalBook file.

The citation provided is a guideline. Please check each citation for accuracy before use.

Looks like it’s one and the same.

#7

On a granular level, yes the definitions are slightly different. However, I think in conversation they are analogous.