What WACC blends together
WACC is the average rate of return a company must pay its investors — both shareholders and lenders — weighted by how much of the company's capital each group supplies. Shareholders require the cost of equity, typically estimated with models such as the Capital Asset Pricing Model; lenders require the cost of debt, observable from the company's actual borrowing rates.
Debt gets a tax adjustment that equity doesn't: because interest payments are generally tax-deductible for corporations, the effective cost of debt is the pre-tax rate multiplied by one minus the tax rate. This interest tax shield is a large part of why debt is typically a cheaper financing source than equity.
The formula and a worked example
WACC weights each financing source's cost by its share of total capital, V = E + D at market values. Equity contributes its full cost; debt contributes its cost reduced by the tax shield on deductible interest.
A company financed with $600 million of equity and $400 million of debt has weights of 60% and 40%. With a 10% cost of equity, a 6% pre-tax cost of debt, and a 25% tax rate: WACC = 0.60 × 10% + 0.40 × 6% × (1 − 0.25) = 6.0% + 1.8% = 7.8%. The after-tax cost of debt alone is 6% × (1 − 0.25) = 4.5%.
- WACC = (E ÷ V) × Re + (D ÷ V) × Rd × (1 − T)
- E = $600M equity, D = $400M debt, V = $1,000M → weights 60% / 40%
- After-tax cost of debt = 6% × (1 − 0.25) = 4.5%
- WACC = 0.60 × 10% + 0.40 × 4.5% = 6.0% + 1.8% = 7.8%
WACC as a hurdle rate, not a score
WACC is primarily used as the discount rate in DCF valuation of a firm's free cash flows, and as the hurdle rate for capital-budgeting decisions on projects of similar risk to the company. It's also the benchmark against which return on invested capital (ROIC) is compared: a company creates economic value only when ROIC exceeds WACC. When ROIC equals WACC, returns exactly cover the cost of capital — no value is created or destroyed; when ROIC falls short of WACC, growth at those returns actually destroys value.
Common mistakes
Using book values instead of market values for the equity and debt weights is a frequent error — WACC is defined on market values, and book equity often bears little relation to market capitalization. Forgetting the tax adjustment on debt overstates its cost. And applying a single company-wide WACC to projects with materially different risk biases the firm toward risky projects and against safe ones, since a single-firm WACC is only an appropriate discount rate for projects of similar risk to the overall company.
Часто задаваемые вопросы
What is the WACC formula?
WACC = (E/V) × Re + (D/V) × Rd × (1 − T), where E and D are the market values of equity and debt, V is their sum, Re is the cost of equity, Rd is the pre-tax cost of debt, and T is the tax rate. With 60% equity at a 10% cost, 40% debt at a 6% pre-tax cost, and a 25% tax rate, WACC = 6.0% + 1.8% = 7.8%.
Why is the cost of debt multiplied by (1 − tax rate)?
Interest payments on debt are generally tax-deductible for corporations, so each dollar of interest expense reduces taxable income and taxes owed. This tax shield lowers the effective cost of borrowing — a 6% pre-tax cost of debt at a 25% tax rate is effectively 4.5% after tax.
What is WACC used for?
WACC is primarily used as the discount rate in discounted cash flow valuation of a firm's free cash flows, and as the hurdle rate for capital-budgeting decisions on projects of similar risk to the company. It's also the benchmark against which return on invested capital (ROIC) is compared.
Should WACC use market values or book values?
Market values. WACC represents the return investors currently require on the capital they have at stake, measured by market values — for equity, market capitalization rather than book equity. Book value of debt is often used as a practical proxy for market value of debt when the debt isn't traded, since the two are usually closer than for equity.
Is there a 'typical' WACC every company should target?
No. WACC varies by industry, capital structure, interest-rate environment, and country. Industry cost-of-capital datasets, such as those published by Aswath Damodaran at NYU Stern, show meaningful and persistent differences across sectors, which is why WACC should be estimated from a company's own inputs rather than assumed from a general target.
Источники
- Damodaran A. Cost of Capital by Sector and Estimating the Cost of Capital. New York University Stern School of Business. pages.stern.nyu.edu/~adamodar.
- CFA Institute. Cost of Capital — CFA Program Curriculum. cfainstitute.org.
- Brealey RA, Myers SC, Allen F. Principles of Corporate Finance. 13th ed. McGraw-Hill Education.
- Koller T, Goedhart M, Wessels D. Valuation: Measuring and Managing the Value of Companies. 7th ed. McKinsey & Company / Wiley, 2020.