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Watch: Calculating WACC Using a Formula

Run time: 4:38Covers: the WACC formula, capital weights, and the after-tax cost of debtTaught by: Dr. Paul Borosky, DBA, MBA

The Short Answer

What Is the WACC Formula?

Answer

WACC is the average rate a company pays for its money, weighted by how much comes from equity and how much comes from debt. Debt gets a tax discount because interest is deductible. The result is the minimum return a new project must earn to create value.

The Formula

WACC = (E/V × Re) + (D/V × Rd × (1 − T))

E
Market value of equity
D
Market value of debt
V
Total capital: E + D
Re
Cost of equity: the return owners require
Rd
Cost of debt: the interest rate on borrowing
T
Corporate tax rate, as a decimal

What Does Your Money Really Cost?

Business ConsultingDr. Paul helps owners turn numbers like these into real decisions on cash, pricing, and growth.See consulting options → Business Plan WritingA complete plan with financial projections that lenders and investors can follow.See business plan prices → Business Plan TemplatesAn editable Word plan and Excel financial model built for your industry.Browse templates → Small Business EducationFree lessons on financial statements, ratios, and the formulas behind them.Start learning free →

Step by Step

How Do You Calculate WACC?

Say a company is funded with $600,000 of equity and $400,000 of debt. Owners require 12%. The loan costs 7%. The tax rate is 25%.

  1. 1

    Add up total capital

    V = $600,000 + $400,000 = $1,000,000.

  2. 2

    Find the weights

    E/V = $600,000 ÷ $1,000,000 = 60%. D/V = $400,000 ÷ $1,000,000 = 40%. The weights must add to 100%.

  3. 3

    Weight the cost of equity

    0.60 × 12% = 7.20%.

  4. 4

    Find the after-tax cost of debt

    7% × (1 − 0.25) = 5.25%. Interest is tax deductible, so the real cost of the loan is lower than the sticker rate.

  5. 5

    Weight the cost of debt

    0.40 × 5.25% = 2.10%.

  6. 6

    Add the pieces

    7.20% + 2.10% = 9.30%. Any project this company takes on needs to earn more than 9.30% to add value.

Where does the 12% cost of equity come from? A common method is CAPM: Re = risk-free rate + beta × market risk premium. With an example risk-free rate of 4%, a beta of 1.2, and a 6% premium, Re = 4% + 1.2 × 6% = 11.20%.

Dr. Paul's Insight

Owners often think debt is "cheap" and equity is "free." Neither is true. Equity is the most expensive money in the business, because owners take the most risk. WACC puts a real price on that risk, so decisions stop being based on gut feel.

In Excel

How Do You Calculate WACC in Excel?

Lay the inputs out in cells and let one formula do the rest. With the example above:

CellInput or formulaResult
B1: Equity600000$600,000
B2: Debt400000$400,000
B3: Cost of equity12%12.00%
B4: Cost of debt7%7.00%
B5: Tax rate25%25.00%
B6: Total capital=B1+B2$1,000,000
B7: After-tax cost of debt=B4*(1-B5)5.25%
B8: WACC=B1/B6*B3+B2/B6*B4*(1-B5)9.30%

Format B8 as a percentage with two decimals. Change the debt in B2 and you can see right away how a new loan shifts the hurdle rate.

Avoid These

What Are the Most Common WACC Mistakes?

  • Skipping the tax shield. Use Rd × (1 − T), not the raw interest rate. Leaving it out overstates WACC.
  • Using book values when market values exist. For a public company, equity should be market value. For a small private company, a reasonable estimate is fine, but say so.
  • Weights that do not add to 100%. Check E/V + D/V = 1 every time.
  • Applying the tax rate to equity. Dividends and owner returns are not tax deductible. Only debt gets the (1 − T).
  • Using one WACC for every project. A risky new venture deserves a higher hurdle than a routine equipment upgrade.

Real World Use

How a Manager Uses WACC

Leadership Meeting

Setting the hurdle rate for next year's project requests

A finance manager is asked to set the hurdle rate leadership will use to approve projects. The company has $3,500,000 of equity and $1,500,000 of debt. Owners expect 14%. The bank loan costs 8%. The tax rate is 21%.

Total capital is $5,000,000, so the weights are 70% equity and 30% debt. Equity piece: 0.70 × 14% = 9.80%. After-tax debt: 8% × (1 − 0.21) = 6.32%, and 0.30 × 6.32% = 1.90%. WACC = 11.70%.

The slide is simple: "Projects must clear 11.70%." A proposal returning 10.5% gets sent back. One returning 13% moves forward. Showing the inputs on the slide, not just the answer, is what earns leadership's trust in the number.

Keep Going

More Videos in This Series

Capital Budgeting Example Solved With NPV, IRR, and Payback

Dr. Paul uses a discount rate like WACC to accept or reject a project. (42:43)

Calculate Beta of a Portfolio in Excel

Dr. Paul calculates beta, the risk input behind the cost of equity. (6:47)

Expected Rate of Return

Dr. Paul explains how investors set the return they expect to earn. (3:03)

Questions

WACC Questions People Ask

What is the WACC formula?
WACC = (E/V × Re) + (D/V × Rd × (1 − T)). E is equity, D is debt, V is their total, Re is the cost of equity, Rd is the cost of debt, and T is the tax rate.
Why is the cost of debt multiplied by one minus the tax rate?
Interest is tax deductible, so every dollar of interest lowers the tax bill. A 7% loan at a 25% tax rate really costs 5.25% after taxes. Equity gets no such break.
What is a good WACC?
There is no single good number. A lower WACC means cheaper money, which makes more projects worth doing. What matters most is that each project earns more than the company's own WACC.
How do you calculate WACC in Excel?
Put equity, debt, cost of equity, cost of debt, and tax rate in cells B1 to B5. Then use =B1/(B1+B2)*B3+B2/(B1+B2)*B4*(1-B5). With $600,000 equity, $400,000 debt, 12%, 7%, and 25%, the result is 9.30%.
Is WACC the same as the hurdle rate?
WACC is the usual starting point for a hurdle rate. Many companies add a cushion for riskier projects. The hurdle rate is the minimum return leadership will accept, and it should never sit below WACC.
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Written by Dr. Paul Borosky, DBA, MBA, current college professor, business consultant, and author with 14+ years and 1,000+ businesses served.

This page is for general educational purposes only. It is not financial, investment, legal, or tax advice.