WACC calculator

What is WACC?

The weighted average cost of capital is the average return a company must pay its lenders and shareholders, each source weighted by its share of the company’s capital at market value. It is often used as the discount rate for projects as risky as the company itself.

What is the formula?

WACC = D% × rd × (1 − T) + P% × rpfd + E% × re, as in OpenStax Principles of Finance, section 17.3. D%, P% and E% are the market-value weights of debt, preferred stock and common equity; rd is the pre-tax cost of debt, T the tax rate, rpfd the cost of preferred stock and re the cost of equity. Debt is taken after tax because interest is tax-deductible.

Example

OpenStax’s Bluebonnet Industries: equity worth $15,000,000, debt worth $4,850,000 (97% of $5 million face), a 6.312% pre-tax cost of debt and a 21% tax rate, so debt costs 4.986% after tax. CAPM with a 3% risk-free rate, beta 1.3 and an 11% market return gives a 13.4% cost of equity. WACC = 24.43% × 4.986% + 75.57% × 13.4% = 11.34%; the book rounds the weights and gets 11.33%.

How do I estimate the cost of equity with CAPM?

Cost of equity = risk-free rate + beta × (expected market return − risk-free rate). OpenStax uses the 10-year Treasury rate for the risk-free rate. The result depends on the inputs you choose; the dividend growth model can give a different figure (14.24% for Bluebonnet, a WACC of 11.98%).

Why market values instead of book values?

Weights should reflect what investors would pay for the company’s debt and stock today. Market value of equity is shares outstanding × share price; debt can trade above or below its face value.

How does WACC relate to net present value?

WACC is commonly used as the discount rate when the project is about as risky as the company. A project that costs $1,000 and returns $400 at the end of each of the next three years has a net present value of $27.87 at the 8.16% WACC of the worked example below, so it would add value; at a 20% discount rate its NPV would be −$157.41, so it would not.

Should the cost of debt be the coupon rate on existing bonds?

No. The cost of debt is what the company would pay to borrow now, which is the current yield on its bonds or the rate on a new loan. A bond issued years ago with a 3% coupon that now yields 6% costs the company 6% for new money. The tax effect is applied after you enter the pre-tax rate.

What each input means

Equity and debt are market values in dollars: shares outstanding times the share price for equity, and the market value of the debt, which can be above or below face value. Preferred stock is optional. The cost of debt is the pre-tax yield; the calculator multiplies it by (1 − tax rate) because interest reduces taxable income. The cost of equity is either entered directly or computed from CAPM as the risk-free rate plus beta times the market risk premium (expected market return minus the risk-free rate). The weights are each source's share of the total, and the WACC is the weighted sum of the costs. All rates are entered in percent.

Worked example: a company that is 60% equity and 40% debt

Equity is worth $60 million and debt $40 million, so the weights are 60% and 40% of $100 million. With a risk-free rate of 4%, a beta of 1.1 and an expected market return of 10%, CAPM gives a cost of equity of 4 + 1.1 × (10 − 4) = 10.6%. Debt costs 6% before tax and 6 × (1 − 0.25) = 4.5% after a 25% tax rate. WACC = 0.60 × 10.6% + 0.40 × 4.5% = 8.16%. Without the tax shield the cost of debt would be 6% and the WACC 8.76%. Shifting to 40% equity and 60% debt at the same costs gives 6.94%, though in practice more debt also raises the cost of both debt and equity, which these inputs do not capture.

Adding preferred stock

Preferred stock is a third source of capital with its own cost, usually its dividend divided by its price. If the example company replaced $10 million of debt with preferred stock at a 7.5% cost, the weights become 60% equity, 30% debt and 10% preferred, and the WACC is 8.46%. Preferred dividends are not tax-deductible in the US, so no tax adjustment is applied to that line.

Limits of WACC

WACC is only as good as its inputs. CAPM depends on the choice of risk-free rate, beta and market return, and different reasonable choices move the cost of equity by several percentage points. The weights are assumed to stay at the target mix; a company that changes its financing changes its WACC. The tax shield is only worth something if the company has taxable income. And a single company-wide rate is not appropriate for a project in a different business or country with different risk, which needs its own rate. Treat the result as an estimate to be tested with a range of inputs.

Common mistakes

Using book values from the balance sheet instead of market values gives wrong weights, especially for equity. Entering the pre-tax cost of debt and forgetting the tax rate overstates the cost, as does entering the tax rate as a decimal when the form expects percent. Using the historical coupon as the cost of debt is another. And mixing up the market return and the market risk premium in CAPM: the form asks for the expected return of the market, from which the risk-free rate is subtracted.

Sources: OpenStax Principles of Finance, chapter 17 (sections 17.1 to 17.3: cost of capital, CAPM and the weighted average cost of capital, including the Bluebonnet Industries example). Related: NPV calculator, ROI calculator and Black-Scholes calculator. Estimates for planning only; not financial or investment advice.

Estimates for planning only — not financial advice. How we check our calculators.