Most firms are financed by a mixture of debt, say from banks and bondholders, and equity from shareholders.

These come at different costs. A firm’s average cost of capital will lie somewhere between those two costs and represents the cost of deploying a pound in the business. Let’s say a firm’s debt costs 4% a year and its equity 8% and it is financed using £100m of each. Its weighted average cost of capital is around 6% ((4%+8%)/2). The higher this is the bigger the return on capital the firm must earn to justify staying in business. If this firm earns say 12% on its capital employed then all is well but if it can consistently only earn say 2% then it is a wealth destroyer.