WACC Calculator
The blended cost of capital across equity and debt, after the interest tax shield.
Capital structure 60.0% equity / 40.0% debt. This is the discount rate for the firm’s own projects at this risk level.
6.00% × (1 − 25%) — the tax shield is why debt costs less than its coupon.
Use market values, not book values — the balance sheet records what equity was issued for, not what it is worth. WACC is only the right discount rate for projects carrying the firm’s existing risk; a venture in a different business needs its own rate.
WACC weights the cost of equity and the after-tax cost of debt by their share of total capital. With 600 of equity at 11.2% and 400 of debt at 6% before a 25% tax rate, WACC is 0.6 × 11.2% + 0.4 × 4.5% = 8.52%.
What a firm pays for its money
A company funds itself from two sources, and each has a price. Shareholders require a return for the risk they carry; lenders require interest. The weighted average cost of capital combines the two in proportion to how much of each the firm uses, giving the minimum return a project must earn to leave investors no worse off.
That makes WACC the natural discount rate for valuing the firm's own projects. A project returning more than WACC creates value; one returning less destroys it, even if it is profitable in accounting terms — profit that fails to cover the cost of the capital tied up is not a gain.
Why debt looks cheaper
Two things make debt cheaper than equity. Lenders are paid before shareholders and often hold security, so they bear less risk and demand less return. On top of that, interest is tax-deductible: a firm paying 6% interest at a 25% tax rate bears a real cost of 4.5%, because the interest reduces its tax bill. That deduction is the tax shield, and it is the (1 − Tc) term in the formula.
This does not mean loading up on debt lowers WACC without limit. As leverage rises, both lenders and shareholders demand more for the increased risk of distress, and beyond some point those rising costs outweigh the tax shield.
E and D are the market values of equity and debt, Re and Rd their costs, and Tc the corporate tax rate. Use market values, not book values.
Worked example: 60% equity, 40% debt
Weights first, then the tax shield, then the average:
- 1 Find the market values. Equity 600 and debt 400, so total capital V = 1000.
- 2 Work out the weights. E/V = 600 ÷ 1000 = 0.60 and D/V = 400 ÷ 1000 = 0.40.
- 3 Take the cost of equity. 11.2%, typically from CAPM. This calculator can derive it for you.
- 4 Apply the tax shield to debt. 6% × (1 − 0.25) = 4.5%. Interest deductibility does the work here.
- 5 Weight and add. 0.60 × 11.2% + 0.40 × 4.5% = 6.72% + 1.80% = 8.52%.
- 6 Use it as the hurdle rate. Projects at this risk level must clear 8.52% to add value.
How WACC moves with the debt share
Holding Re at 11.2%, Rd at 6%, and tax at 25%. This is the mechanical effect only — in reality both costs rise as leverage increases.
| Debt share | Equity share | WACC |
|---|---|---|
| 0% | 100% | 11.20% |
| 20% | 80% | 9.86% |
| 40% | 60% | 8.52% |
| 60% | 40% | 7.18% |
| 80% | 20% | 5.84% |
The mistakes that matter
The most common error is using book values from the balance sheet. Book equity records what shares were originally issued for, sometimes decades ago; the cost of capital depends on what investors could sell them for today. For a listed company, market capitalisation is the right figure — shares outstanding times the current price.
The second is applying one WACC to everything. WACC reflects the risk of the firm's existing business. A stable manufacturer evaluating a software venture cannot discount it at the manufacturer's WACC, because the venture is not that risk. The standard fix is to use a divisional or industry rate built from comparable firms.
The table above also carries a trap worth naming: read literally, it suggests that ever more debt keeps lowering WACC, which would imply a firm should be almost entirely debt-financed. It does not work that way, because Re and Rd are held fixed in the table but rise in practice as leverage grows. That is the whole substance of capital-structure theory, and it is why real firms settle at moderate leverage rather than at the extremes.