Use this rate for your Net Present Value (NPV) calculations.
function calculateWACC() {
// Get Input Values
var rf = parseFloat(document.getElementById('riskFreeRate').value);
var beta = parseFloat(document.getElementById('beta').value);
var rm = parseFloat(document.getElementById('marketReturn').value);
var preTaxRd = parseFloat(document.getElementById('costOfDebt').value);
var taxRate = parseFloat(document.getElementById('taxRate').value);
var equityVal = parseFloat(document.getElementById('equityValue').value);
var debtVal = parseFloat(document.getElementById('debtValue').value);
// Validation
if (isNaN(rf) || isNaN(beta) || isNaN(rm) || isNaN(preTaxRd) || isNaN(taxRate) || isNaN(equityVal) || isNaN(debtVal)) {
alert("Please fill in all fields with valid numbers.");
return;
}
if (equityVal + debtVal <= 0) {
alert("Total value (Equity + Debt) must be greater than zero.");
return;
}
// 1. Calculate Cost of Equity (CAPM)
// Formula: Re = Rf + Beta * (Rm – Rf)
var costOfEquity = rf + beta * (rm – rf);
// 2. Calculate After-Tax Cost of Debt
// Formula: Rd_after_tax = PreTaxRd * (1 – TaxRate)
var taxDecimal = taxRate / 100;
var costOfDebtAfterTax = preTaxRd * (1 – taxDecimal);
// 3. Calculate Weights
var totalValue = equityVal + debtVal;
var weightEquity = equityVal / totalValue;
var weightDebt = debtVal / totalValue;
// 4. Calculate WACC
// Formula: WACC = (We * Re) + (Wd * Rd_after_tax)
var wacc = (weightEquity * costOfEquity) + (weightDebt * costOfDebtAfterTax);
// Display Results
document.getElementById('displayRe').innerHTML = costOfEquity.toFixed(2) + "%";
document.getElementById('displayRd').innerHTML = costOfDebtAfterTax.toFixed(2) + "%";
document.getElementById('displayWe').innerHTML = (weightEquity * 100).toFixed(2) + "%";
document.getElementById('displayWd').innerHTML = (weightDebt * 100).toFixed(2) + "%";
document.getElementById('displayWACC').innerHTML = wacc.toFixed(2) + "%";
// Show Results Area
document.getElementById('results-area').style.display = 'block';
}
Understanding the Current Discount Rate for NPV Calculation
When performing a Net Present Value (NPV) analysis to evaluate the profitability of an investment or project, selecting the correct **discount rate** is the most critical step. The discount rate represents the opportunity cost of capital—essentially, the return an investor expects to earn on an investment with a similar risk profile.
Using an incorrect discount rate can lead to significant valuation errors, causing businesses to either reject profitable projects or accept unprofitable ones. The standard method for determining this rate for corporate finance decisions is the **Weighted Average Cost of Capital (WACC)**.
How to Calculate the Discount Rate
The calculator above uses the WACC formula, which combines the cost of equity and the cost of debt, weighted by their respective proportions in the company's capital structure.
WACC = (E/V × Re) + (D/V × Rd × (1 – T))
Where:
Re: Cost of Equity (calculated via CAPM).
Rd: Cost of Debt (pre-tax interest rate).
E: Market value of the firm's equity.
D: Market value of the firm's debt.
V: Total value of capital (E + D).
T: Corporate Tax Rate.
1. The Cost of Equity (CAPM)
The cost of equity is the return required by shareholders. Since equity costs are not explicit like interest payments, they are estimated using the Capital Asset Pricing Model (CAPM):
Re = Rf + β × (Rm – Rf)
Risk-Free Rate (Rf): Usually the yield on 10-year government treasury bonds.
Beta (β): A measure of how much the stock moves relative to the market. A beta of 1.0 means average volatility; higher than 1.0 implies higher risk.
Market Risk Premium (Rm – Rf): The additional return investors demand for holding risky assets over risk-free assets.
2. The Cost of Debt
This is generally easier to determine than the cost of equity. It is the effective interest rate a company pays on its debts. Crucially, because interest expenses are tax-deductible, the effective cost of debt is reduced by the tax rate (Tax Shield).
Why is the Discount Rate Critical for NPV?
Net Present Value (NPV) is the sum of present values of incoming and outgoing cash flows over a period of time. Money in the future is worth less than money today due to inflation and opportunity cost.
Higher Discount Rate: Reduces the present value of future cash flows. This is used for riskier projects.
Lower Discount Rate: Increases the present value of future cash flows. This is used for stable, low-risk projects.
Real-World Example Calculation
Imagine a company considering a new factory. To find the discount rate, we analyze their financials:
Risk-Free Rate: 4% (10-Year T-Bill)
Beta: 1.5 (High volatility sector)
Market Return: 10%
Cost of Debt: 6% interest rate
Tax Rate: 25%
Capital Structure: 60% Equity ($6M), 40% Debt ($4M)
Step 1: Cost of Equity
Re = 4% + 1.5 * (10% – 4%) = 13%