Calculate the weighted average cost of capital (WACC) from equity and debt weights, costs, and the corporate tax rate.
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Corporate Finance
The weighted average cost of capital (WACC) is the blended minimum return a company must earn on its existing assets to satisfy all capital providers — both equity investors and debt holders.
WACC represents the opportunity cost of deploying capital in a business. It serves as the discount rate in DCF valuations and the hurdle rate for capital budgeting. Projects earning above WACC create value; those below destroy it.
The formula weights each capital source by its proportion in the capital structure and adjusts the cost of debt for the tax shield.
WACC blends equity and after-tax debt costs.
WACC = (E/V × Ke) + (D/V × Kd × (1 − T))
E/V = equity weight, Ke = cost of equity, D/V = debt weight, Kd = cost of debt, T = corporate tax rate.
60% equity at 11.1%, 40% debt at 5%, 25% tax rate. After-tax cost of debt = 5% × 0.75 = 3.75%. WACC = 0.6 × 11.1% + 0.4 × 3.75% = 6.66% + 1.50% = 8.16%.
WACC assumes a constant capital structure and constant cost of capital, which rarely holds in practice. Market-value weights should be used rather than book values, but market values fluctuate daily. The tax shield benefit only applies when the company is profitable enough to utilise it.
Frequently asked questions
Market values are theoretically correct because they reflect the current cost to investors. Book values may differ significantly, especially for equity. Use market capitalisation for equity weight and market value of debt (or book value as a proxy for investment-grade debt).
Initially WACC may fall because debt is cheaper than equity (due to the tax shield). But beyond a point, additional leverage increases financial risk, raising both the cost of equity and the cost of debt, eventually increasing WACC.
Only if the project has the same risk profile as the overall company. For projects with materially different risk, use a project-specific discount rate based on comparable-company betas.
Enterprise value = present value of future free cash flows discounted at WACC. A lower WACC increases the present value of cash flows and thus enterprise value.
Related
These related calculators come from the same leaf category, nearby sibling categories, or the same top-level topic.
Calculate the cost of equity using CAPM (risk-free rate, beta, market return) or the dividend discount model (Gordon Growth).
Calculate enterprise value from market capitalization, debt, preferred equity, minority interest, and cash, then review the bridge from equity value to EV.
Calculate the effective interest cost after accounting for tax-deductible interest payments, then compare the pre-tax rate, after-tax rate, and tax shield.
Calculate the debt-to-equity ratio from total debt and total equity, then review debt and equity shares of capital plus the equity cushion per dollar of debt.
