Weighted Average Cost of Capital (WACC): Definition, Formula, and How to Calculate It
WACC is the average rate that a company is expected to pay to finance its assets, weighted by capital structure.
Exact Formula:
Where Re = cost of equity, Rd = cost of debt, E = market value of equity, D = market value of debt, Tc = corporate tax rate.
Notes
- WACC is widely used as a discount rate in DCF models
- Estimating Re often uses CAPM; Rd uses market yields adjusted for default risk
- Higher WACC means higher required returns and lower valuations
Why This Matters:
WACC is the hurdle rate for investment decisions and the discount rate in most valuation models. Companies with lower WACC have competitive advantages in capital allocation and typically command higher valuations.