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WACC

In short

Weighted Average Cost of Capital — the discount rate for DCF

WACC is the average rate a company pays for all its funding — both equity (shareholders expect returns) and debt (banks charge interest). It's the minimum return a company must earn to create value.

WACC blends the cost of equity (estimated via CAPM) and cost of debt (interest rate × (1-tax rate)), weighted by the company's capital structure. Used as the discount rate in DCF analysis. Lower WACC means future cash flows are worth more today.

Formula

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

Thresholds

<6
Low — large stable company
6-10
Normal range
10-15
Higher risk business
>15
Very risky — high required return

Related concepts

  • DCF Model — Imagine a friend promises to pay you $100/year for 10 years. Would you pay $1,000 today? Not quite — money tomorrow is worth less than money today. DCF calculates what future cash flows are worth right now.
  • Risk-Free Rate — The rate you earn on the safest available investment, typically short- to medium-term government debt. Everything else gets compared against it — if a 10-year government bond pays 4%, why accept only 3% from a riskier stock or corporate bond with no extra compensation?
  • Equity Risk Premium — If government bonds pay 4% and investors demand 10% from stocks to compensate for the extra risk, the difference — 6 percentage points — is the equity risk premium. It's the extra return investors require, on average, for accepting stock market risk instead of a safer bond.
  • Cost of Debt — If a company borrowed $1 million at 5% interest, its pre-tax cost of debt is 5%. But since interest payments are tax-deductible, the after-tax cost is lower — about 3.5% at a 30% tax rate, since the tax savings partly offset the interest actually paid out.