What Is WACC and How Do You Calculate It?
WACC is the blended rate a company pays for its money — and the discount rate behind most investment decisions. Here's the definition, the formula, and the mistakes that cost marks.
The weighted average cost of capital, or WACC, is the average rate of return a company must earn to satisfy all its providers of finance — shareholders and lenders together. It blends the cost of equity and the after-tax cost of debt, weighted by how much of each the company uses. WACC is the rate most often used to discount a project's cash flows in investment appraisal.
The formula
In its standard form, WACC = the cost of equity times the proportion of equity, plus the after-tax cost of debt times the proportion of debt. The weights are based on market values, not book values, and the cost of debt is taken after tax because interest is tax-deductible.
The two components
- Cost of equity — usually found using the capital asset pricing model (CAPM): the risk-free rate plus beta times the equity risk premium.
- Cost of debt — the after-tax return required by lenders, found from the interest rate or, for traded debt, the yield to redemption (the internal rate of return of the bond's cash flows).
The common mistakes
Three errors cost marks repeatedly: using book values instead of market values for the weights, forgetting to take debt after tax, and applying a company's WACC to a project with a different risk profile than the existing business — where a project-specific rate built from a degeared and regeared beta is required instead.
The takeaway
WACC is the blended cost of a company's finance and the default discount rate for appraisal: weight equity and after-tax debt by market value, build the cost of equity from CAPM, and only use WACC where the project matches the firm's risk.
The formula is easy to quote and easy to misapply under time pressure. The 50% Club marks your practice FM answers against the official ACCA scheme, showing exactly where a weight, a tax adjustment or a risk assumption cost you a mark — and which method marks you still earned.