WACC Explained: How to Calculate Your Cost of Capital
September 22, 2026
WACC (Weighted Average Cost of Capital) blends the cost of a company's equity and debt, weighted by how much of each makes up its capital structure: WACC = (E/V × Re) + (D/V × Rd × (1 − Tc)), where V = E + D. It represents the minimum return a company needs to earn on its assets to satisfy both shareholders and lenders.
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A company has $600,000 in market value of equity and $400,000 in market value of debt, so total capital V = $1,000,000. Its cost of equity is 12%, its cost of debt is 6%, and its tax rate is 21%.
- Equity weight: $600,000 / $1,000,000 = 60%
- Debt weight: $400,000 / $1,000,000 = 40%
- After-tax cost of debt: 6% × (1 − 0.21) = 4.74%
- WACC = (0.60 × 12%) + (0.40 × 4.74%) = 7.2% + 1.896% = 9.10%
Why Market Value, Not Book Value
WACC uses the market value of equity and debt, not their accounting (book) value, because market value reflects what investors would actually have to pay to acquire that equity or debt today. A company's book equity (from its balance sheet) is often wildly different from its market capitalization, especially for growth companies — using book value would misstate the true cost of raising that capital.
Estimating the Cost of Equity
Unlike debt, equity has no stated interest rate, so its cost is estimated — most commonly with CAPM (Capital Asset Pricing Model): Cost of Equity = Risk-Free Rate + Beta × (Market Return − Risk-Free Rate). Beta measures how volatile the stock is relative to the overall market; a beta above 1 implies more volatility (and a higher required return) than the market average.
Why Debt Gets an After-Tax Discount
Interest payments on debt are tax-deductible, which effectively subsidizes part of a company's borrowing cost. Multiplying the cost of debt by (1 − tax rate) captures this: at a 21% tax rate, a 6% cost of debt has a true after-tax cost of only 4.74%, since the interest deduction shields roughly a fifth of that cost from taxation.
Frequently Asked Questions
What is WACC used for?
WACC serves two main purposes: as the discount rate in a discounted cash flow (DCF) valuation, and as the minimum hurdle rate a new investment project's expected return (IRR) must clear to be worth pursuing.
Why use market value instead of book value for WACC?
Market value reflects what equity and debt are actually worth today to investors and creditors — book value from the balance sheet can be significantly out of date, especially for equity, whose market value often diverges sharply from its accounting value.
How do I calculate the cost of equity?
The most common method is CAPM: Cost of Equity = Risk-Free Rate + Beta × (Market Return − Risk-Free Rate). The risk-free rate is often a government bond yield, and beta and the market risk premium are typically sourced from financial data providers.
Why is the cost of debt multiplied by (1 − tax rate)?
Interest expense is tax-deductible, so the true cost of debt to the company is lower than its stated interest rate — the (1 − tax rate) adjustment captures this tax shield.
What does a low WACC mean?
A low WACC means a company can raise capital more cheaply, often reflecting lower perceived risk, more stable cash flows, or favorable market conditions — it also means a lower bar for what returns new investments need to clear to be worthwhile.