WACC — weighted average cost of capital — is the return a company has to earn just to satisfy everyone who funded it. Lenders want their interest; shareholders want a return that compensates them for the risk of owning equity. Blend the two, weighted by how much of each the company uses, and you get WACC.
It matters because it's the discount rate in most valuations. Future cash is worth less today, and WACC is how much less. Get it wrong and every downstream number is wrong with it.
The two halves
- Cost of debt is the easy one: roughly the interest rate the company pays, reduced for the tax deduction on interest. Borrow at 6% with a 25% tax rate and your after-tax cost is about 4.5%.
- Cost of equity is the slippery one. Shareholders have no promised return, so you estimate what they'd reasonably demand — usually via CAPM: the risk-free rate plus the stock's beta times the equity risk premium. A volatile stock (high beta) carries a higher cost of equity.
Weight each by its share of the capital structure and add them up. A company that's 30% debt, 70% equity blends 30% of its after-tax debt cost with 70% of its equity cost.
A quick example
| Component | Cost | Weight | Contribution |
|---|---|---|---|
| Debt (after tax) | 4.5% | 30% | 1.35% |
| Equity | 9.0% | 70% | 6.30% |
| WACC | ~7.65% |
Why it's the dial that matters most
In a DCF, a one-percentage-point change in WACC can move the valuation 15–20%, because it compounds across every future year. That's a feature and a trap: it means the rate has to be defensible, and it means anyone can quietly manufacture the answer they wanted by nudging it. When you read someone's valuation, the WACC is the first assumption worth interrogating.
Bottom line
WACC is the hurdle rate: earn more than it and the company creates value, earn less and it destroys value. In a model it's the discount rate, and it's powerful enough that small changes swing the output hard — so treat it as a judgement to defend, not a plug.