⚖️cost of-capital

WACC

WACC = (E/V)×Re + (D/V)×Rd×(1-T)

Weighted average cost of capital blends the cost of equity and after-tax cost of debt using market-value weights.

Variables

E/V=Equity Weight

Market value of equity / total value

D/V=Debt Weight

Market value of debt / total value

Re=Cost of Equity

Required return on equity (often from CAPM)

Rd=Cost of Debt

Interest rate on debt

T=Tax Rate

Corporate tax rate

Example Calculation

Scenario

Equity is 60% of value with Re = 12%. Debt is 40% with Rd = 6%. Tax rate is 25%.

Given Data

E/V:60%
Re:12%
D/V:40%
Rd:6%
T:25%

Calculation

WACC = 0.60 × 0.12 + 0.40 × 0.06 × (1-0.25) = 0.072 + 0.018 = 0.09

Result

9.0%

Interpretation

The firm needs to earn at least 9% on new projects to satisfy both debt and equity investors.

When to Use This Formula

  • Discount rate for NPV of firm-level projects
  • Valuation models (DCF)
  • Comparing capital structure alternatives

Common Mistakes

  • Using book weights instead of market weights
  • Forgetting the (1-T) tax adjustment on debt

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FAQs

Common questions about this formula

Yes. Changes in capital structure, interest rates, or equity risk premium all affect WACC.

Market values reflect what investors would actually pay today. Book values are historical and may not represent the true cost of raising new capital. Market-value weights produce a more accurate cost of capital for decision-making.

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