How is WACC defined in terms of capital structure?

WACC, or Weighted Average Cost of Capital, is defined as the collective cost of equity and cost of debt weighted according to the proportion of each in a company's capital structure. It represents the overall required return of a firm and is critical for financial modeling and investment decision-making.

Understanding WACC is essential because it reflects how a firm finances its operations and growth through a mix of debt and equity. Each component has a different cost; for instance, debt generally has a lower cost due to tax advantages, while equity carries higher risks and thus a higher cost. By integrating these costs, WACC gives a comprehensive view of what a firm must earn to satisfy its investors.

The average return on total equity alone focuses only on one portion of a firm's capital and does not capture the complete financing picture. The estimated market value of shareholders primarily deals with equity valuation without considering the cost of debt. Lastly, the return rate of risky investments does not directly relate to the weighted average calculation of capital costs used in corporate finance. Therefore, understanding WACC as the collective cost of equity and cost of debt is fundamental for effective financial analysis and decision-making within a company.