valuation-inputscalculatedCritical

Weighted Average Cost of Capital

Blended cost of debt and equity financing, weighted by capital structure.

waccAlso: WACC

Definition

The Weighted Average Cost of Capital (WACC) represents the minimum return a company must earn on its existing asset base to satisfy its creditors, owners, and other providers of capital. It reflects the opportunity cost of investing capital in a specific business versus alternative investments with similar risk.

Why It Matters

WACC is the discount rate used in DCF analysis. A higher WACC reduces present value of future cash flows, lowering valuation. It directly impacts investment decisions and capital allocation.

Formula

= (E/V) × Re + (D/V) × Rd × (1 - Tc)

Equity weight times cost of equity, plus debt weight times after-tax cost of debt.

Mathematical Notation

WACC = \frac{E}{V} \times R_e + \frac{D}{V} \times R_d \times (1 - T_c)

Alternative Approaches

With preferred stock= (E/V) × Re + (P/V) × Rp + (D/V) × Rd × (1 - Tc)

Company has preferred equity in capital structure

Typical Ranges

startup

15%–25%

growth

10%–15%

mature

6%–10%

declining

8%–12%

Industry-Specific Ranges

Technology10%–14%

Utilities5%–7%

Financial Services8%–12%

Healthcare8%–11%

Consumer Staples6%–9%

Best Practices

Use market values for debt and equity weights, not book values. Cost of equity should be derived from CAPM or comparable analysis. Ensure tax rate reflects marginal rate applicable to interest deductions.

Common Mistakes

✕Using book value instead of market value for weights
✕Applying wrong tax rate (statutory vs effective vs marginal)
✕Not updating beta for leverage changes
✕Using risk-free rate from wrong duration

Pro Tips

✓Sensitivity test WACC ±1-2% to see valuation impact
✓Consider unlevered beta when comparing across capital structures
✓Document all assumptions clearly for audit trail

Dependencies

Inputs (This variable depends on)

Cost of Equity

Affects (Variables that depend on this)

Terminal Value

Audit & Governance

Risk Level

Critical

Approval Required

manager

Sensitivity

internal

Track Changes

Yes

Learning Path

beginner

Think of WACC as the "hurdle rate" - the minimum return needed to satisfy all capital providers. If a project earns less than WACC, it destroys value.

intermediate

Focus on getting the weights right (use market values) and understanding the tax shield on debt. The tax benefit of debt is why levered firms often have lower WACC.

advanced

Consider iterative WACC calculations when debt levels change materially over forecast period. May need to unlever/relever beta for accurate cost of equity.

expert

In complex situations, consider using APV (Adjusted Present Value) instead of WACC when capital structure changes significantly or has unusual features.