How to use the WACC calculator
The WACC tool needs four groups of inputs, in millions of dollars:
- Value of equity. Enter the market capitalization, or the share price and the diluted share count. Use market values, not shareholders’ equity from the balance sheet.
- Cost of equity. Choose CAPM and enter the risk-free rate, the stock’s beta and an equity risk premium, or type in a cost of equity you have estimated another way. The CAPM calculator explains each input.
- Debt. Enter the market value of debt, then either the pre-tax rate the company would pay to borrow today or its annual interest expense, which the calculator divides by the debt. Add the tax rate at which interest is deducted; 21% is the US federal corporate rate before state taxes.
- Preferred stock and book equity, both optional. Preferred stock gets its own weight and cost. Book equity is only used to show how much WACC changes at book-value weights.
The Cost of debt tool estimates the pre-tax rate three ways: the yield to maturity on one of the company’s bonds, a Treasury yield plus a credit spread, or interest expense divided by average debt.
The WACC formula
V = E + D + P
Re = Rf + β × ERPE, D and P are the market values of equity, debt and preferred stock. Re is the cost of equity, Rd the pre-tax cost of debt, t the tax rate and Rp the preferred dividend yield. Rf is the risk-free rate, β the beta and ERP the equity risk premium.
Each source of capital is weighted by its share of the total. Debt carries the (1 − t) factor because interest reduces taxable income; the annual saving, debt × rate × tax rate, is called the interest tax shield.
A worked example
Company A has a market capitalization of $6,000M and $2,000M of debt, so total capital is $8.00B. Equity is 75.0% of the total and debt 25.0%.
With a risk-free rate of 4.25%, a beta of 1.1 and an equity risk premium of 5%, CAPM gives a cost of equity of 9.75%. The company borrows at 6%; at a 21% tax rate that costs 4.74% after tax, and the interest saves $25.20M of tax a year.
Weighting the two: WACC is 8.50%. A project with the same risk as Company A’s existing business adds value only if it returns more than that.
Market weights versus book weights
The weights should reflect what each claim is worth today, because that is the amount investors could take out and invest elsewhere. For debt the difference is usually small: unless rates have moved sharply or the company’s credit has changed, bonds trade near their face value, and book debt is a fair stand-in.
Equity is another matter. Shareholders’ equity on the balance sheet records the capital paid in plus retained profits, at historical cost. A profitable company’s shares usually trade well above that. Company A’s book equity is $2,500M against a market value of $6,000M; at book weights debt looks much larger and WACC drops to 7.52%. Using that lower rate in a DCF would make every cash flow look more valuable than it is. The bar chart under the calculator shows both sets of weights.
There is one practical exception: when a company is private, or its shares are thinly traded, analysts often use a target capital structure, such as the average of comparable listed companies, rather than either value.
How the capital structure changes WACC
Debt is cheaper than equity, so it is tempting to think more borrowing always lowers WACC. Holding every cost fixed, the calculator seems to agree:
| Debt (market value) | Debt weight | WACC |
|---|---|---|
| None | 0.0% | 9.75% |
| $2,000M (the example) | 25.0% | 8.50% |
| $4,000M | 40.0% | 7.75% |
| $6,000M, costs unchanged | 50.0% | 7.25% |
| $6,000M, beta 1.6 and debt at 8% | 50.0% | 9.29% |
The fourth row is misleading. With half its capital in debt, Company A’s shareholders carry far more risk, so its beta rises, and lenders demand a higher rate. The last row puts in plausible higher costs, and WACC is 9.29%, above the example’s figure. This is the Modigliani–Miller insight in practical form: beyond the tax saving on interest, changing the mix of funding mostly shifts risk between investors rather than removing it. If you test a different capital structure, re-lever beta and reprice the debt as well.
The tax rate matters for the same reason. With no tax deduction for interest, the example’s WACC would be 8.81% instead of 8.50%.
Estimating the cost of debt
The cost of debt in WACC is the rate the company would pay to borrow today, not the coupon on bonds it issued years ago. The Cost of debt tool offers three routes:
- Bond yield. A 5.25% bond with 7 years left, priced at $96.50, yields 5.87% to maturity, or 4.63% after tax. This is the most direct market evidence.
- Treasury plus spread. A 4.25% Treasury yield plus a 1.6% credit spread gives 5.85%. Use it when the company has a credit rating or close peers but no liquid bonds.
- Interest ÷ debt. $120M of interest on average debt of $2.00B gives 6.00%. It is easy to calculate but backward-looking, because it reflects rates locked in over past years.
For a company in distress, the yield on its bonds includes compensation for expected default losses, so it overstates the true cost of debt. Analysts then use a lower figure based on the rating or the expected recovery.
Limitations
The result is only as good as the cost of equity, which cannot be observed directly: beta is estimated from noisy past returns and equity risk premium estimates differ by source and method. Small changes move the answer, as the sensitivity table shows. The calculator uses a single tax rate and assumes the company can use the full interest deduction, which may not hold for loss-making firms or when US interest limitation rules apply. It treats leases, pension deficits and convertibles only if you add them to debt yourself. And one WACC suits only projects with the same risk as the whole company; a riskier division or a new market deserves a higher rate.