WACC Calculator
Weighted average cost of capital from equity, debt and the tax rate.
About
WACC Calculator
Weighted average cost of capital is what a company pays, on average, for the money it uses. Shareholders expect a return and lenders charge interest, so every project the company funds has to clear that combined rate before it creates any value. WACC is the number that hurdle is set from.
The formula
WACC = (E÷V × cost of equity) + (D÷V × cost of debt × (1 - tax rate))
E is the market value of equity, D the market value of debt, and V the two added together. The weights are simply each source's share of the total funding, and the tax adjustment appears because interest is deductible while dividends are not.
A worked example
A company is funded by $700,000 of equity and $300,000 of debt. Shareholders expect 9%, the loans carry 6%, and the corporate tax rate is 21%.
- Weights: equity 70%, debt 30%
- Equity contributes: 70% × 9% = 6.30%
- After-tax cost of debt: 6% × (1 - 0.21) = 4.74%
- Debt contributes: 30% × 4.74% = 1.42%
- WACC: 6.30% + 1.42% = 7.72%
A project returning 9% adds value. One returning 6% destroys it, even though 6% sounds like a profit, because the money funding it costs more than that.
Why debt looks cheap
Two things make debt the cheaper source. Lenders take less risk than shareholders because they are paid first and hold a claim on assets, so they accept a lower return. On top of that, interest is deductible against tax.
In the example, $300,000 at 6% costs $18,000 of interest a year. Deducting it saves 21% of that, or $3,780, so the real cost is $14,220 and the effective rate is 4.74%. That saving is the tax shield, and it is the reason companies carry debt they could technically repay.
The obvious question follows: why not fund everything with debt? Because the risk of not being able to pay it rises with every loan, and both lenders and shareholders start demanding more. The chart on this page holds both costs fixed to show the mechanical effect, which is why the line falls in a straight run. Real capital costs bend upward at the leveraged end.
Finding the cost of equity
Nobody sends an invoice for the cost of equity, so it has to be estimated. The capital asset pricing model is the standard route:
cost of equity = risk-free rate + beta × equity risk premium
The risk-free rate is usually a ten-year government bond yield. Beta measures how much the share moves relative to the market, with 1.0 meaning it moves in step. The equity risk premium is the extra return equities are expected to deliver over bonds, commonly taken as 4% to 6%.
A share with a beta of 1.2, a 4% risk-free rate and a 5% premium gives 4% + 1.2 × 5% = 10%. Small changes to the premium move the answer a lot, which is worth remembering before treating a WACC as precise to two decimal places.
Market values, not book values
The weights must use market values. Book equity is a historical accounting figure and is often nowhere near what the company is worth. A firm with $50 million of book equity and a $400 million market capitalisation is 89% equity funded against $50 million of debt, and using the book figure would suggest a 50/50 split and produce a badly wrong WACC.
Debt is more forgiving, since loans and recently issued bonds usually trade close to face value. Where a bond trades well below par because rates have risen, use the market price.
What WACC is used for
Three main jobs. It is the discount rate in a discounted cash flow valuation, where future cash is converted into today's money. It is the hurdle rate for investment decisions, so a project has to beat it. And it is a benchmark for the company itself, since a business earning a return on capital below its WACC is shrinking in value while showing an accounting profit.
That last point catches people out. Profit and value are different tests, and a company can pass one while failing the other for years.
Where it stops working
WACC describes the risk of the company as a whole. Using it for a project with a different risk profile is wrong in a predictable direction: safe projects get rejected and risky ones get approved, because the same rate is applied to both. A stable utility moving into software should not discount the software at the utility's WACC.
It also assumes the capital structure stays roughly where it is. A leveraged buyout that changes the debt share every year needs adjusted present value or a year-by-year rate instead.
Using WACC on a real decision
A project needs $500,000 up front and is expected to return $120,000 a year for six years. Discounting those returns at the 7.72% WACC gives a present value of $559,455, so the net present value is $59,455 and the project is worth doing.
Change nothing except the discount rate and watch what happens. At 9% the present value falls to $538,310 and the NPV to $38,310. The project survives, but a third of its value has gone on a rate change of just over a percentage point.
The rate at which the NPV reaches zero is the internal rate of return, here 11.53%. That is the project's own return, and comparing it to the WACC gives the margin of comfort: 11.53% against 7.72% leaves nearly four points of room before the decision reverses.
How sensitive the answer is
Because the cost of equity is estimated, it is worth seeing how much the WACC moves when the estimate does.
| Cost of equity | WACC |
|---|---|
| 7% | 6.32% |
| 8% | 7.02% |
| 9% | 7.72% |
| 10% | 8.42% |
| 11% | 9.12% |
Every percentage point on the cost of equity moves the WACC by 0.7 points, because equity carries 70% of the weight. In a company funded mostly by equity, the CAPM estimate drives almost the whole answer, and the sensible response is to run the valuation across a range rather than quoting a single figure.
Levered and unlevered
Two versions of beta circulate and mixing them produces a WACC that is quietly wrong. Levered beta, sometimes called equity beta, includes the effect of the company's debt and is what you see quoted on financial data sites. Unlevered beta, or asset beta, strips that out to describe the underlying business risk on its own.
Comparing companies with different debt levels means unlevering each one first, averaging, then re-levering at your own debt ratio. Skipping that step imports someone else's capital structure into your cost of equity, and the error compounds through everything the WACC touches.
Common mistakes
Using book values for the weights. The single most common error, and it can move the answer by several percentage points.
Forgetting the tax adjustment. Leaving out (1 - tax rate) overstates the cost of debt and the WACC with it.
Including trade payables as debt. Only interest-bearing debt belongs in D. Supplier credit and accruals do not.
Treating the result as exact. The cost of equity is an estimate built on other estimates. A WACC of 7.7% is really a statement that the number is somewhere near 8%.
Common questions
Frequently asked questions
Most established companies land somewhere between 6% and 12%, with stable, heavily regulated businesses at the low end and volatile or early-stage ones far above it. The figure depends on interest rates at the time, so a WACC calculated in a low-rate year is not comparable to one from a high-rate year.
Because it lowers the bar. A company with a WACC of 6% can profitably fund projects returning 7%, while a company at 12% cannot. Lower capital costs also raise valuations directly, since future cash flows are discounted less heavily.
After-tax, because interest is deductible and the company only bears the net cost. Enter the pre-tax rate the lender charges along with the tax rate, and the calculation makes the adjustment. Cost of equity gets no such treatment, since dividends are paid out of taxed profit.
Take the average beta of listed companies in the same industry, remove the effect of their debt to get an unlevered beta, then re-lever it using your own debt ratio. The result is an estimate with real uncertainty in it, so test the WACC across a range of betas rather than trusting one.
WACC is the blended cost across all funding sources. A required rate of return is what one particular investor or project demands. They coincide when a project carries the same risk as the company, and diverge as soon as it does not.
Constantly. It moves with interest rates, the share price, the debt level and the tax rate. Companies typically recalculate it annually, or sooner after a large financing event, and use the same figure across the year for consistency in project appraisals.
Not in any realistic case. It would require negative costs of both equity and debt, meaning investors pay for the privilege of funding you. Some government bonds have carried negative yields, but the equity component keeps the blended figure positive.
Because the chart holds both costs constant while shifting weight toward the cheaper source, which is the mechanical effect in isolation. In practice lenders demand more as leverage rises and shareholders demand more still, so the real curve turns upward past some point and the theoretical optimum sits at that turn.