Discount rate · Cost of capital · DCF input
Weighted Average Cost of Capital (WACC): Formula & Calculator
WACC is the minimum return a company must earn across all its capital to satisfy equity investors and debt holders. It is the discount rate in every DCF model and the hurdle rate in every ROIC comparison.
WACC is the blended cost of all capital a company uses, weighted by how much of each type it carries — equity at market value times its required return, debt at market value times its after-tax cost. WACC formula: WACC = (E/V) × Re + (D/V) × Rd × (1 − T). E = market value of equity. D = market value of debt. V = E + D. Re = cost of equity (from CAPM). Rd = pre-tax cost of debt. T = corporate tax rate. The tax term exists because interest is tax-deductible, so debt is cheaper on an after-tax basis.
WACC Variables Explained
How to Calculate WACC: 4 Steps
- Calculate the cost of equity using CAPM. The CAPM formula gives: Re = Rf + β × (Rm − Rf). Use the current 10-year Treasury yield as Rf, the stock's beta from a financial data provider, and a forward equity risk premium of ~5–5.5% for US stocks.
- Find the pre-tax cost of debt. For publicly traded bonds, use the yield-to-maturity. For companies without traded debt, divide annual interest expense by average total debt. See the full after-tax cost of debt formula for details.
- Calculate capital structure weights using market values. Divide market capitalization by (market cap + total debt) to get E/V. Divide total debt by the same denominator to get D/V. Use market values — book values are historical artifacts, not what investors actually bid today.
- Plug into the WACC formula. Multiply each weight by its corresponding cost, apply the (1 − T) tax shield to the debt component, and sum. The result is your discount rate for DCF models and your hurdle rate for ROIC comparisons.
WACC Example: Apple (AAPL)
Using publicly available inputs as of late 2024: market cap ~$3.1T, long-term debt ~$101B, 10-yr Treasury yield 4.4%, beta 1.24 (Yahoo Finance), ERP 5.5% (Damodaran), effective tax rate ~15%.
- Market cap (E)
- $3,100B
- Long-term debt (D)
- $101B
- Total capital (V = E + D)
- $3,201B
- Equity weight (E/V)
- 96.8%
- Debt weight (D/V)
- 3.2%
- Cost of equity (CAPM: 4.4% + 1.24 × 5.5%)
- 11.2%
- After-tax cost of debt (3.0% × (1 − 15%))
- 2.55%
- Equity contribution (96.8% × 11.2%)
- 10.84%
- Debt contribution (3.2% × 2.55%)
- 0.08%
- WACC = 10.84% + 0.08%
- ≈ 10.9%
Apple must earn at least 10.9% on new investments to create shareholder value. Because Apple is almost entirely equity-financed, its WACC closely tracks its cost of equity — companies with more leverage will see a larger contribution from the debt term.
How Investors Use WACC
Discount rate in DCF models. Every cash flow in a DCF model is discounted back to today using WACC. A higher WACC means future cash flows are worth less now — small changes in WACC can swing a valuation by 20–30%. This is why WACC estimation matters as much as the cash flow forecast itself.
ROIC vs. WACC spread. The most direct test of whether a company creates value is whether its return on invested capital exceeds its WACC. ROIC > WACC means every dollar invested generates more than it costs; ROIC < WACC means the company would be better off returning capital to shareholders. This spread is the clearest single-number signal of competitive advantage.
Terminal value discount rate. In a two-stage DCF, the terminal value accounts for the majority of total value — often 60–80%. That terminal value is divided by (WACC − g), so even a 0.5% error in WACC meaningfully changes the terminal value estimate.
Common WACC Mistakes
- Using book-value weights instead of market-value weights. Book values are historical cost — they reflect what was paid for assets, not what investors value the company at today. Market values represent the actual opportunity cost of capital and are the correct inputs.
- Forgetting the tax shield on debt. Interest expense reduces taxable income. The true cost of debt to the firm is Rd × (1 − T), not the coupon rate. Omitting the (1 − T) term overstates WACC and undervalues the business.
- Applying one company-wide WACC to all projects. A mature cash cow division and an early-stage R&D unit have different risk profiles. Using the blended WACC for both will undervalue safe projects and overfund risky ones.
- Using historical stock returns as the equity risk premium. Historical returns embed realized surprises and changing valuations. A forward-looking ERP estimate (Damodaran publishes one annually) better reflects what investors actually demand going forward.