Understanding WACC
Definition & Significance
WACC (Weighted Average Cost of Capital) represents the minimum required rate of return for a company to satisfy all its investors—both equity holders and debt providers. It serves as the threshold rate that determines whether a business investment generates or destroys value.
In practical terms: investments yielding returns above the WACC create shareholder value, while those yielding below the WACC destroy value. This makes WACC an essential metric for capital budgeting, valuation, and strategic decision-making.
The WACC Formula
Where:
- EMarket value of equity
- DMarket value of debt
- keCost of equity capital
- kdCost of debt capital
- TCorporate tax rate
Note: The formula weights each component by its relative proportion in the capital structure.
Cost of Equity (ke)
The cost of equity represents the return expected by shareholders for their investment. It's typically calculated using the Capital Asset Pricing Model (CAPM), with additional risk premiums:
- rfRisk-free rate (typically government bond yield)
- βLLevered beta (measure of systematic risk)
- MRPMarket Risk Premium
- SPSize Premium (Duff & Phelps methodology)
- ARAdditional Risk Premium (company-specific)
Unlevered vs Levered Beta
Levered beta (βL) reflects both business risk and financial risk from leverage. It's derived from the unlevered beta (βU), which measures only business risk:
Cost of Debt (kd)
The cost of debt represents the effective interest rate a company pays on its debt financing, typically calculated as:
The credit spread is determined by the company's risk profile, primarily assessed through metrics like the interest coverage ratio (ICR) and resulting credit rating. The after-tax cost is used in the WACC formula because interest payments are tax-deductible in most jurisdictions.
Data Sources
Our calculator uses industry-standard financial data from authoritative sources:
Risk-Free Rate & Market Risk Premium
Beta by Industry
Damodaran, Betas by Sector, Global
Corporate Marginal Tax Rates
Damodaran, Corporate Marginal Tax Rates - By country
Size Risk Premium
Duff & Phelps research and methodology
Debt Default Spread
Damodaran, Ratings, Interest Coverage Ratios and Default Spread
Practical Applications
Capital Budgeting
Used as the discount rate in NPV calculations to evaluate potential investments and projects.
Business Valuation
Serves as the discount rate in DCF models to determine the present value of future cash flows.
Capital Structure
Helps identify the optimal debt-to-equity ratio that minimizes the company's overall cost of capital.
Using Our Calculator
Follow these steps to calculate your company's WACC:
- 1
Select country and industry sector
This provides location-specific tax rates and sector-specific unlevered betas
- 2
Enter company size (market capitalization)
Used to calculate the appropriate size premium
- 3
Add financial metrics
EBIT and interest expenses help determine the interest coverage ratio
- 4
Provide capital structure details
The ratio of equity to debt in your company's financing
- 5
Review suggested parameters
Adjust any values if needed based on your specific situation
- 6
Calculate and analyze the results
View a detailed breakdown of your WACC components