Why is weighted average cost of capital important to a business?

A simple answer: because it has a direct bearing on what the company is worth.

The easiest way to see this is to consider how the business value is determined using the well-known Discounted Cash Flow valuation method. The cost of capital is a major input here in the form of the discount rate.

The higher the discount rate the less the company is worth, given a business earnings forecast. In other words, the cost of capital indicates how risky the business is. Higher cost of capital indicates a business that is more risky. To be valuable, the company must generate higher earnings to compensate.

This is just another way of saying that a business investment value is about both the risk and return.

See Valuation Tour