Input Parameters
When to Use WACC
- Discounting free cash flows in DCF valuation
- Evaluating investment projects (NPV hurdle rate)
- Comparing companies' cost of capital
- Making capital structure decisions
WACC Result
Step-by-Step Calculation
Sensitivity Analysis
WACC across different costs of equity and debt weights:
Understanding WACC
What is WACC?
The Weighted Average Cost of Capital (WACC) is the average rate of return a company must earn on its existing assets to satisfy its creditors, owners, and other providers of capital. It represents the blended cost of all funding sources, weighted by their proportion in the company's capital structure.
WACC is one of the most important concepts in corporate finance because it serves as the discount rate for evaluating investment decisions, performing DCF valuations, and assessing whether a company is creating or destroying value.
The Formula
WACC = (E/V) × Re + (D/V) × Rd × (1 - Tc)
- E/V = Equity weight (market value of equity ÷ total firm value)
- D/V = Debt weight (market value of debt ÷ total firm value)
- Re = Cost of equity (required return demanded by shareholders)
- Rd = Cost of debt (pre-tax interest rate on borrowing)
- Tc = Corporate tax rate (makes debt cheaper via the tax shield)
Why Debt Has a Tax Advantage
Interest payments on debt are tax-deductible, meaning the government effectively subsidizes the cost of debt financing. The after-tax cost of debt is Rd × (1 - Tc), which is always lower than the pre-tax cost when the tax rate is positive.
For example, if a company borrows at 6% and the tax rate is 25%, the after-tax cost of debt is only 4.5%. This tax shield is a key reason why companies include debt in their capital structure, even though excessive debt increases financial risk.
Common Uses
- Discount rate for DCF valuation
- NPV hurdle rate for capital budgeting
- Benchmark for project returns
- Comparing capital efficiency across firms
Limitations
- Assumes constant capital structure
- Cost of equity is estimated, not observed
- May not reflect project-specific risk
- Tax rate assumptions can vary
Frequently Asked Questions
WACC is the average rate of return a company must pay to finance its assets, weighted by the proportion of each funding source. The formula is WACC = (E/V) × Re + (D/V) × Rd × (1 - Tc), where E is equity value, D is debt value, V is total value (E+D), Re is cost of equity, Rd is cost of debt, and Tc is the corporate tax rate. It is commonly used as the discount rate in DCF valuations.
Debt is cheaper than equity for two reasons. First, debt holders have priority over equity holders in bankruptcy, so they accept a lower return for lower risk. Second, interest payments on debt are tax-deductible, creating a tax shield that reduces the effective cost. The after-tax cost of debt is Rd × (1 - Tc), which is always lower than the pre-tax cost when the tax rate is positive.
You should use market values, not book values, when calculating WACC. Market value of equity is the company's market capitalization (share price × shares outstanding). For debt, market value is ideal but book value is often used as an approximation since most corporate debt trades close to par. Using book values for equity can significantly understate the equity weight and distort the WACC calculation.
The most common method is the Capital Asset Pricing Model (CAPM): Re = Rf + β × (Rm - Rf), where Rf is the risk-free rate (typically 10-year Treasury yield), β measures the stock's sensitivity to market movements, and (Rm - Rf) is the equity risk premium (historically 4-7%). Alternatives include the Fama-French three-factor model and the dividend discount model implied cost of equity.
WACC is one type of discount rate, specifically used to discount free cash flows to the firm (FCFF) in a DCF valuation. It reflects the blended cost of all capital sources. However, not all discount rates are WACC. When discounting cash flows to equity (FCFE), you use the cost of equity alone. For project-specific analysis, you might use a project-specific discount rate that reflects that project's unique risk profile rather than the company's overall WACC.
Disclaimer
This calculator is for educational and informational purposes only. It is not financial advice. WACC calculations depend heavily on input assumptions, particularly the cost of equity, which is estimated rather than directly observed. Results should be used alongside other valuation methods and professional judgment. Always verify financial data from official sources and consult with qualified professionals for investment decisions.
