The formula weights cost-of-equity by the equity share of capital and after-tax cost-of-debt by the debt share. Debt is cheaper because interest is tax-deductible and lenders rank ahead of owners, so more debt lowers WACC until default risk starts raising both components.
WACC is also the hurdle in economic-profit and the benchmark for return-on-invested-capital. A business earning less than its WACC is consuming value even while reporting a profit.
Example: Northwind Tools is 80% equity at a 9.0% cost and 20% debt at 5.5% pre-tax, 4.2% after a 24% tax rate. WACC is 0.8 times 9.0 plus 0.2 times 4.2, or 8.1%.
Related: cost-of-equity, cost-of-debt, discount-rate, return-on-invested-capital, economic-profit