Weighted Average Cost of Capital (WACC) Calculator
Accurately calculate your company's WACC to understand its cost of financing and guide investment decisions.
WACC Calculation Inputs
The return required by equity investors.
The interest rate on your company's debt.
Total market value of the company's outstanding shares.
Total market value of the company's outstanding debt.
The company's effective corporate tax rate.
WACC Calculation Results
–.–%
Weight of Equity: –.–%
Weight of Debt: –.–%
After-Tax Cost of Debt: –.–%
Formula: WACC = (E/V * Re) + (D/V * Rd * (1 – Tc))
Where E = Market Value of Equity, D = Market Value of Debt, V = E + D, Re = Cost of Equity, Rd = Cost of Debt, Tc = Corporate Tax Rate.
Where E = Market Value of Equity, D = Market Value of Debt, V = E + D, Re = Cost of Equity, Rd = Cost of Debt, Tc = Corporate Tax Rate.
WACC Components Breakdown
Contribution of Equity and Debt to WACC
WACC Calculation Details
| Component | Value | Weight | Cost | After-Tax Cost | Weighted Contribution |
|---|---|---|---|---|---|
| Equity | — | –.–% | –.–% | –.–% | –.–% |
| Debt | — | –.–% | –.–% | –.–% | –.–% |
| Total WACC | –.–% | ||||
What is Weighted Average Cost of Capital (WACC)?
The Weighted Average Cost of Capital, commonly known as WACC, is a crucial financial metric used to represent a company's overall cost of capital. It is essentially the blended average rate that a company expects to pay to finance its assets. WACC takes into account the proportion of each type of capital (like equity and debt) in a company's capital structure and their respective costs. Understanding your company's WACC is fundamental for making sound financial decisions, such as evaluating potential investment projects, mergers, and acquisitions. It acts as a hurdle rate; projects with expected returns higher than WACC are generally considered financially viable, while those below WACC may not be worth pursuing.
Who Should Use WACC?
WACC is primarily used by financial analysts, corporate finance managers, investors, and business owners. It's invaluable for:
- Capital Budgeting: Determining if new projects or investments are likely to generate sufficient returns to cover the cost of financing.
- Valuation: Discounting future cash flows to their present value when valuing a company or its assets. A higher WACC leads to a lower present value, and vice versa.
- Performance Evaluation: Assessing how effectively a company is using its capital.
- Strategic Planning: Guiding decisions about capital structure (i.e., the optimal mix of debt and equity).
Common Misconceptions about WACC
Several common misconceptions exist regarding WACC. Firstly, it's not simply the average of the cost of debt and cost of equity; the "weighted" aspect is critical. Secondly, WACC is a forward-looking metric, reflecting expected future costs, not just historical ones. Lastly, while the tax deductibility of interest payments reduces the effective cost of debt, WACC calculations must use the *after-tax* cost of debt, not just the interest rate. This calculation is vital for accurate financial modeling.
WACC Formula and Mathematical Explanation
The WACC formula is derived by summing the product of each component's weight in the capital structure and its associated cost. For a company with only common equity and debt, the formula is:
WACC = (E / V * Re) + (D / V * Rd * (1 – Tc))
Step-by-Step Derivation:
- Identify Capital Components: Determine all sources of external capital, typically common equity and debt. Preferred stock, if any, would also be included.
- Determine Market Values: Find the current market value of each capital component. For equity, this is market capitalization (share price * shares outstanding). For debt, it's the market price of outstanding bonds or the book value if market values are not readily available.
- Calculate Total Capital Value (V): Sum the market values of all capital components (V = E + D).
- Calculate Weights: Determine the proportion (weight) of each component in the total capital structure. Weight of Equity (E/V) = Market Value of Equity / Total Capital Value. Weight of Debt (D/V) = Market Value of Debt / Total Capital Value. The sum of weights must equal 1 (or 100%).
- Determine Cost of Equity (Re): This is the rate of return equity investors expect. It can be estimated using models like the Capital Asset Pricing Model (CAPM).
- Determine Cost of Debt (Rd): This is the interest rate the company pays on its debt. It's typically the yield to maturity on its outstanding bonds.
- Apply Tax Shield: Since interest payments on debt are tax-deductible, the effective cost of debt is reduced. Calculate the after-tax cost of debt: Rd * (1 – Tc), where Tc is the corporate tax rate.
- Calculate WACC: Multiply each component's weight by its respective after-tax cost and sum these products.
Variable Explanations:
Here's a breakdown of the variables used in the WACC calculation:
| Variable | Meaning | Unit | Typical Range |
|---|---|---|---|
| E | Market Value of Equity | Currency ($) | Varies widely by company size |
| D | Market Value of Debt | Currency ($) | Varies widely by company size |
| V | Total Market Value of Capital (E + D) | Currency ($) | Sum of E and D |
| Re | Cost of Equity | % | 8% – 15% (can be higher/lower) |
| Rd | Cost of Debt (Pre-Tax) | % | 3% – 10% (can be higher/lower) |
| Tc | Corporate Tax Rate | % | 20% – 35% (depending on jurisdiction) |
| WACC | Weighted Average Cost of Capital | % | Typically between Re and after-tax Rd, weighted average |
Practical Examples (Real-World Use Cases)
Let's illustrate WACC with two practical examples:
Example 1: Tech Startup
- Market Value of Equity (E): $50,000,000
- Market Value of Debt (D): $10,000,000
- Cost of Equity (Re): 15.0%
- Cost of Debt (Rd): 7.0%
- Corporate Tax Rate (Tc): 25.0%
Calculation:
- Total Capital (V) = $50,000,000 + $10,000,000 = $60,000,000
- Weight of Equity (E/V) = $50M / $60M = 0.8333 or 83.33%
- Weight of Debt (D/V) = $10M / $60M = 0.1667 or 16.67%
- After-Tax Cost of Debt = 7.0% * (1 – 0.25) = 5.25%
- WACC = (0.8333 * 15.0%) + (0.1667 * 5.25%)
- WACC = 12.50% + 0.875% = 13.375%
Interpretation: This tech startup needs to achieve a return of at least 13.38% on its investments to satisfy its investors and lenders. Given its high proportion of equity and higher cost of equity, its WACC is relatively high.
Example 2: Established Manufacturing Company
- Market Value of Equity (E): $200,000,000
- Market Value of Debt (D): $150,000,000
- Cost of Equity (Re): 10.0%
- Cost of Debt (Rd): 6.0%
- Corporate Tax Rate (Tc): 21.0%
Calculation:
- Total Capital (V) = $200,000,000 + $150,000,000 = $350,000,000
- Weight of Equity (E/V) = $200M / $350M = 0.5714 or 57.14%
- Weight of Debt (D/V) = $150M / $350M = 0.4286 or 42.86%
- After-Tax Cost of Debt = 6.0% * (1 – 0.21) = 4.74%
- WACC = (0.5714 * 10.0%) + (0.4286 * 4.74%)
- WACC = 5.714% + 2.031% = 7.745%
Interpretation: This established company has a lower WACC of approximately 7.75%. This reflects its larger size, potentially lower risk profile, and significant use of cheaper, tax-advantaged debt. It can therefore consider projects with lower expected returns compared to the startup.
How to Use This WACC Calculator
Our WACC calculator is designed for simplicity and accuracy. Follow these steps to compute your company's Weighted Average Cost of Capital:
- Input Cost of Equity: Enter the required rate of return for your company's equity investors, typically derived from models like CAPM.
- Input Cost of Debt: Enter the current interest rate your company pays on its debt (pre-tax).
- Input Market Value of Equity: Provide the total market capitalization of your company (share price multiplied by the number of outstanding shares).
- Input Market Value of Debt: Enter the total market value of your company's outstanding debt. If market values are unavailable, use book values as an approximation.
- Input Corporate Tax Rate: Enter your company's effective corporate income tax rate.
- Click 'Calculate WACC': The calculator will instantly display your company's WACC, along with key intermediate values like the weights of equity and debt, and the after-tax cost of debt.
How to Read Results:
- Primary Result (WACC %): This is your company's overall cost of capital. Aim for this number to be as low as possible, indicating efficient financing.
- Intermediate Values: These show the capital structure weights and the effective cost of debt after considering tax savings.
- Table and Chart: These provide a detailed visual breakdown, showing how equity and debt contribute to the overall WACC.
Decision-Making Guidance:
Use your calculated WACC as a benchmark. When evaluating new investment opportunities, compare their expected rate of return against your WACC. If the project's return exceeds your WACC, it's likely to create value for shareholders. If it falls short, it might destroy value. Continuously review your capital structure and costs to potentially lower your WACC, making your company more competitive.
Key Factors That Affect WACC Results
Several dynamic factors influence a company's Weighted Average Cost of Capital:
- Market Risk Premium: A higher overall market risk premium tends to increase the cost of equity (Re), thereby increasing WACC. This reflects investor expectations for compensation for investing in the stock market overall.
- Company-Specific Risk: Higher operational or financial risk associated with a particular company (e.g., volatile industry, high leverage) will increase its cost of equity and potentially its cost of debt, leading to a higher WACC.
- Interest Rates: Increases in prevailing market interest rates directly raise the cost of debt (Rd). If a company needs to refinance or issue new debt, it will face higher borrowing costs, increasing WACC.
- Capital Structure Weights: The relative proportions of debt and equity significantly impact WACC. Using more debt can lower WACC if debt is cheaper than equity and the tax shield benefits are substantial, but excessive debt increases financial risk and the cost of both debt and equity. Balancing these is key to optimizing WACC.
- Corporate Tax Rate: A higher corporate tax rate (Tc) amplifies the benefit of the debt tax shield, making the after-tax cost of debt lower and potentially reducing WACC. Changes in tax policy can thus affect a company's financing costs.
- Company Growth and Profitability: Mature, stable companies with strong cash flows typically have lower WACC than high-growth, volatile startups. Investors perceive less risk in stable businesses, demanding lower returns.
- Credit Rating: A company's creditworthiness directly impacts its cost of debt. A lower credit rating means higher perceived risk by lenders, leading to a higher Rd and consequently a higher WACC.
Frequently Asked Questions (FAQ)
What is the difference between WACC and the cost of capital?
WACC is a specific calculation representing the weighted average cost of all capital sources. "Cost of capital" is a broader term that can sometimes refer to just the cost of equity or debt, but most often, WACC is used synonymously with the company's overall cost of capital.
Can WACC be negative?
In rare, theoretical situations involving significant subsidies or negative interest rates on debt, WACC could potentially be negative. However, for practical business purposes, WACC is almost always positive, as capital sources have associated costs.
How often should WACC be recalculated?
WACC should be recalculated whenever there are significant changes in the company's capital structure, market conditions (interest rates, risk premiums), or the company's risk profile. Annually is a common practice for stable companies.
What if my company has preferred stock?
If your company has preferred stock, you need to include it in the WACC calculation. The formula would extend to: WACC = (E/V * Re) + (D/V * Rd * (1 – Tc)) + (P/V * Rp), where P is the market value of preferred stock, V is the total value of equity, debt, and preferred stock, and Rp is the cost of preferred stock.
Is WACC the discount rate for all projects?
WACC is the appropriate discount rate for projects that have the same risk profile and financing mix as the company as a whole. For projects with significantly different risk levels, a project-specific discount rate should be used instead of the company's overall WACC.
How is the Cost of Equity (Re) typically calculated?
The most common method is the Capital Asset Pricing Model (CAPM): Re = Rf + Beta * (Rm – Rf), where Rf is the risk-free rate, Beta is the stock's volatility relative to the market, and (Rm – Rf) is the equity market risk premium.
Should I use book values or market values for E and D?
Market values are theoretically preferred because they reflect current investor expectations and the true cost of capital. If market values are unavailable or highly volatile, book values can be used as a proxy, but this introduces potential inaccuracies.
What is the impact of a lower corporate tax rate on WACC?
A lower corporate tax rate reduces the tax savings benefit from debt. This means the after-tax cost of debt increases, which in turn typically leads to a higher WACC, assuming the capital structure remains constant.