~1 min read
WACC (Weighted Average Cost of Capital) is the minimum return a company must earn on its existing assets to satisfy its capital providers — both equity holders and debt holders. It serves as the hurdle rate for investment decisions and DCF valuations.
WACC formula
WACC = (E/V) × Rₑ + (D/V) × Rᵈ × (1 − Tᶜ)
Where: - E = Market value of equity (market cap) - D = Market value of debt - V = E + D (total capital) - Rₑ = Cost of equity (%) - Rᵈ = Pre-tax cost of debt (%) - Tᶜ = Corporate tax rate (%)
Cost of equity is usually estimated with CAPM: risk-free rate + beta × equity risk premium. Beta measures how volatile a stock is relative to the overall market — a beta of 1.5 means the stock tends to move 50% more than the market in either direction, which investors demand a higher return for holding.
Why does the tax rate matter?
Debt interest is tax-deductible, which creates a "tax shield." The after-tax cost of debt is Rᵈ × (1 − Tᶜ). A company with 6% cost of debt and 25% tax rate has an effective debt cost of 4.5%.
Typical WACC benchmarks
| Industry | Typical WACC |
|---|---|
| SaaS / Software | 8–14% |
| Consumer goods | 6–10% |
| Utilities | 4–8% |
| Biotech | 12–20% |
WACC in practice
- DCF valuations: WACC is the discount rate applied to future free cash flows
- Capital budgeting: only accept projects with IRR > WACC
- Capital structure decisions: optimise the mix of equity and debt to minimise WACC
- Performance measurement: ROIC > WACC means the company creates economic value