wacc - capm, page-14

WACC, as it's name suggests, represents how much a company "pays" for its funds (its cost of capital). Using extremes, if a company is 100% debt funded, its cost of capital is the interest on that debt. If a company is 100% equity funded than its cost of capital is the average return that investors expect. This cost of equity is higher than debt, since there is more risk involved, and is theoretically calculated using the CAPM formula as posted above. Usually companies are funded using a combination of both so if a company is 50% debt / 50% equity funded, the WACC is half way between the costs of debt and equity - hence the Weighted Average in WACC. Costs of capital differ - a bank with lots of debt funding will have a lower WACC than a risky junior miner with 100% equity funding.

A WACC is used in valuation as a discount rate. Let me use an example - say a company with one shareholder expects to sell $100 of ore today at no cost. For that shareholder, their investment is worth $100, since the company will bank $100 and pay out a $100 dividend today. Take another company with the same circumstances but will sell the ore 10 years from now rather than today. You would not pay $100 for this company to receive $100 ten years from now - you waste ten years not earning your expected return on your investment. You discount that future $100 by the company's WACC (which effectively represents the money that the company's funders could be earning elsewhere) to arrive at a value for the shares in the company.

The above is all theoretical of course but its how instos go about valuing things.