Cost of Capital (WACC)

How to Calculate the Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) represents the average return a company must pay to all its capital providers — both debt holders and equity investors. It is widely used as the discount rate in Discounted Cash Flow (DCF) valuation when valuing the entire firm.

Formula

$$WACC = \left(\frac{E}{V} \times R_e\right) + \left(\frac{D}{V} \times R_d \times (1 – T)\right)$$WACC=(VE​×Re​)+(VD​×Rd​×(1−T))

Where:

• E = Market value of equity
• D = Market value of debt
• V = E + D (total capital)
• Rₑ = Cost of equity
• R_d = Cost of debt
• T = Corporate tax rate

Debt is multiplied by (1 − T) because interest expense is tax-deductible (tax shield benefit).

How to Calculate WACC (Example)

Assume a company has:

• Market value of equity = $600 million
• Market value of debt = $400 million
• Cost of equity (Rₑ) = 12%
• Cost of debt (R_d) = 6%
• Corporate tax rate = 25%

First calculate weights:
E/V = 600 / 1000 = 60%
D/V = 400 / 1000 = 40%

Now apply formula:
WACC = (0.60 × 12%) + (0.40 × 6% × (1 − 0.25))
WACC = 7.2% + (0.40 × 6% × 0.75)
WACC = 7.2% + 1.8%
WACC = 9.0%

Why WACC Matters

If the company earns returns above 9%, it creates value. If returns are below 9%, it destroys value. WACC is central to valuation, capital budgeting, and investment decisions.