Understanding your WACC
WACC is a hurdle rate rather than a score, so its interpretation depends on what it is compared against. The table below summarizes the standard comparisons.
| Comparison | Reading |
|---|---|
| ROIC > WACC | The company earns more on invested capital than its capital costs — value is being created |
| ROIC = WACC | Returns exactly cover the cost of capital — no economic value added or destroyed |
| ROIC < WACC | Returns fall short of the cost of capital — growth at these returns destroys value |
| Project IRR vs. WACC | Projects of similar risk to the firm are conventionally accepted when their expected return exceeds WACC |
- WACC should use market values for equity and debt weights; book values, especially for equity, can differ substantially from market values and distort the weights.
- The single-firm WACC is only an appropriate discount rate for projects of similar risk to the overall company; riskier or safer projects warrant adjusted rates.
- Every input is an estimate — the cost of equity in particular depends on model assumptions (beta, equity risk premium), so WACC is best treated as a range rather than a precise figure.
What is WACC?
The weighted average cost of capital 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, while lenders require the cost of debt, observable from the company's borrowing rates.
Debt receives an adjustment for taxes: 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 tax shield is why debt is typically a cheaper financing source than equity, and why the after-tax cost of debt appears in the WACC formula.
WACC serves as the standard discount rate in discounted cash flow (DCF) valuation of a whole firm and as the hurdle rate against which returns on invested capital (ROIC) are compared: a company creates value only when its projects earn more than the blended cost of financing them. Valuation references such as Aswath Damodaran's NYU Stern materials emphasize using market values, not book values, for the equity and debt weights.
How to use this WACC calculator
- Enter the market value of equity in millions — for a public company, its market capitalization.
- Enter the market value of debt in millions; book value of debt is often used as a practical approximation when market values are unavailable.
- Enter the cost of equity as a percentage — the return shareholders require, often estimated with the Capital Asset Pricing Model.
- Enter the pre-tax cost of debt as a percentage — the rate the company pays on its borrowings.
- Enter the corporate tax rate; the calculator applies it to the cost of debt to reflect the interest tax shield.
- Read the WACC, the equity weight, and the after-tax cost of debt.
The formula behind WACC
WACC weights each financing source's cost by its share of total capital (V = E + D at market values). Equity contributes its full cost, while debt contributes its cost reduced by the tax shield on deductible interest.
For example, a company financed with $600 million of equity and $400 million of debt (60% / 40% weights), a 10% cost of equity, a 6% pre-tax cost of debt, and a 25% tax rate has WACC = 0.60 × 10% + 0.40 × 6% × (1 − 0.25) = 6.0% + 1.8% = 7.8%.
Common mistakes
- Using book values instead of market values for the equity and debt weights — WACC is defined on market values, and book equity often bears little relation to market capitalization.
- Forgetting the tax adjustment on debt, which overstates the cost of debt since interest is generally tax-deductible for corporations.
- Applying the company-wide WACC to projects with materially different risk, which biases the firm toward risky projects and against safe ones.
- Treating WACC as constant — it shifts as interest rates, the company's capital structure, and its risk profile change, so a WACC estimated in one environment can be stale in another.
- Double-counting financing effects by discounting equity-only cash flows at WACC; WACC pairs with free cash flow to the firm, while cash flows to equity should be discounted at the cost of equity.
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 therefore taxes owed. This interest tax shield lowers the effective cost of borrowing to the pre-tax rate multiplied by one minus the tax rate — 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 is also the benchmark against which return on invested capital (ROIC) is compared: a company creates economic value only when its ROIC exceeds its WACC.
Should I use market values or book values in WACC?
Market values. WACC represents the return investors currently require on the capital they have at stake, which is measured by market values — for equity, the 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 is not traded, since the two are usually closer than for equity.
What is a typical WACC?
WACC varies by industry, capital structure, interest-rate environment, and country; there is no single typical value that applies across companies. 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 always be estimated from a company's own inputs rather than assumed.
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.