How to Calculate WACC (Weighted Average Cost of Capital)
Short answer. Multiply the cost of equity by the equity share of total capital, add the after-tax cost of debt multiplied by the debt share, and you have WACC. With 60% equity at 10% and 40% debt at 5% pre-tax with a 25% tax rate, WACC is 7.5%.
The formula
WACC = E/V x Re + D/V x Rd x (1 - Tax rate)
Step by step
- Measure capital. E is the market value of equity, D the market value of debt, V = E + D.
- Estimate the cost of equity. Often from CAPM: risk-free rate + beta x equity risk premium.
- Estimate the cost of debt. The current yield the company would pay on new debt, then multiply by (1 - tax rate).
- Weight and add. Each cost multiplied by its share of V.
Worked example
A company with 60% equity and 40% debt
- Cost of equity 10%; pre-tax cost of debt 5%; tax rate 25%.
- After-tax cost of debt = 5% x (1 - 0.25) = 3.75%.
- WACC = 0.60 x 10% + 0.40 x 3.75% = 6.0% + 1.5% = 7.5%.
Common mistakes
- Using book values instead of market values for the weights.
- Forgetting the tax shield on debt.
- Using the coupon on old debt rather than the current market cost.
Frequently asked questions
What is WACC used for?
It is the discount rate in a discounted cash flow valuation and a hurdle rate for projects.
Why is debt cheaper than equity?
Lenders have priority in a default and interest is tax deductible.
Does a higher WACC lower valuation?
Yes. A higher discount rate reduces the present value of future cash flows.
General education, not personal financial advice. Example figures are illustrative.