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
Market value of equity / total value
Market value of debt / total value
Required return on equity (often from CAPM)
Interest rate on debt
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
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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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.