WACC Explained: Formula, Inputs & Interview Use
WACC is the discount rate in every DCF. Get the WACC formula, how to estimate cost of equity via CAPM and cost of debt, plus interview follow-ups.
Jun 14, 2026 · 7 min read
WACC, the weighted average cost of capital, is the blended rate of return a company must earn to satisfy all of its capital providers, both debt and equity holders. It is the single most important discount rate in finance, because a DCF discounts unlevered free cash flow at WACC to find a company's present value. The WACC formula weights the after-tax cost of debt and the cost of equity by their share of the total capital structure. Mechanically, it is the cost of equity times the equity weight plus the after-tax cost of debt times the debt weight. Because unlevered cash flows belong to everyone with a claim on the business, you discount them at the rate that reflects everyone's required return, which is exactly what WACC measures.
TL;DR
- WACC is the blended cost of debt and equity, weighted by their share of total capital.
- Formula: WACC = (E/V × Re) + (D/V × Rd × (1 − T)), per Corporate Finance Institute.
- Cost of equity (Re) is estimated with CAPM: Re = Rf + β × (Rm − Rf).
- Cost of debt is multiplied by (1 − tax rate) because interest is tax-deductible.
- A DCF discounts unlevered free cash flow at WACC because that cash belongs to all investors.
What is WACC?
WACC is the average rate of return a company needs to pay all its security holders to finance its assets. It blends two costs: the return equity investors demand for the risk they take, and the interest rate the company pays on its debt, adjusted for the tax savings interest provides. According to Corporate Finance Institute, WACC represents the firm's overall cost of capital across common shares, preferred shares, and debt. A company creates value only when its returns exceed its WACC, so WACC also functions as a hurdle rate for investment decisions, not just a discount rate in valuation.
What is the WACC formula?
The WACC formula weights each source of capital by its market-value proportion and sums the results. Per CFI, the formula is:
Here E is the market value of equity, D is the market value of debt, V is total capital (E plus D), Re is the cost of equity, Rd is the cost of debt, and T is the tax rate. The weights E/V and D/V are based on market values, not book values, because you want the cost of raising capital today. The debt term is multiplied by (1 − T) because interest payments reduce taxable income, which lowers the real cost of debt. This tax shield is why debt is usually cheaper than equity.
How do you estimate the cost of equity?
The cost of equity is the return shareholders require for holding the stock, and it is almost always estimated with the Capital Asset Pricing Model (CAPM). CAPM ties expected return to a single risk factor: how much the stock moves with the broader market. The formula, per CFI, is:
Rf is the risk-free rate, usually the yield on a 10-year government bond. Beta measures the stock's volatility relative to the market, where a beta of 1 moves with the market and a beta above 1 is more volatile. The term (Rm − Rf) is the equity risk premium, the extra return investors expect for holding stocks over risk-free bonds. Multiply that premium by beta and add the risk-free rate to get the required return on equity.
How do you estimate the cost of debt and the weights?
The cost of debt is the rate a company currently pays to borrow, and the weights are the market-value mix of debt and equity. For the cost of debt, you take the weighted-average yield to maturity on the company's outstanding debt, then multiply by (1 − tax rate) to capture the tax shield. For the weights, you use market values: equity weight is market cap divided by total capital, and debt weight is market debt divided by total capital.
| Input | How to estimate it | Common source |
|---|---|---|
| Risk-free rate (Rf) | Yield on 10-year government bonds | Treasury data |
| Beta (β) | Regress stock returns vs. market, or use a levered peer beta | Bloomberg, Barra |
| Equity risk premium | Historical or implied market premium over Rf | Damodaran data |
| Cost of debt (Rd) | Yield to maturity on existing debt, after tax | Bond pricing, filings |
| Capital weights (E/V, D/V) | Market value of equity and debt over total | Market cap, debt schedule |
Because beta is observed for a leveraged company, analysts often unlever and relever it to match the target capital structure before plugging it into CAPM.
Why does a DCF discount at WACC?
A DCF discounts unlevered free cash flow at WACC because unlevered cash flow is the cash available to every capital provider before financing, so it must be discounted at the blended return every provider requires. If you discounted that same cash flow at the cost of equity alone, you would be applying only the shareholders' required return to money that also belongs to lenders, which overstates the discount and understates value. The match between numerator and denominator is the core logic: unlevered cash to all investors, discounted at WACC, the cost of capital to all investors. This is why a DCF built on unlevered free cash flow produces enterprise value, not equity value, in its first pass.
Frequently Asked Questions
Why is the cost of debt multiplied by (1 minus the tax rate)?
Interest expense is tax-deductible, so every dollar of interest a company pays reduces its taxable income and lowers its tax bill. Multiplying the cost of debt by (1 − tax rate) captures this tax shield, giving the true after-tax cost of borrowing, which is what actually affects the company's value.
Is WACC the same as the cost of equity?
No. The cost of equity is only the return shareholders require, while WACC blends the cost of equity with the after-tax cost of debt, weighted by the capital structure. For an all-equity company with no debt, WACC and the cost of equity are equal, but most companies carry debt, so their WACC is lower than their cost of equity.
What makes WACC go up or down?
WACC rises when interest rates climb, when a company's beta increases, or when the equity risk premium widens, since each raises a component cost. It falls when a company adds cheaper debt to its structure, up to the point where the added financial risk starts pushing the cost of equity higher.
Should you use book or market values for the weights?
Market values. WACC is meant to reflect the cost of raising capital today, and investors price securities at market, not book. Using book values, especially for equity, can badly distort the weights for a company whose market cap differs from its accounting equity.
What is a typical WACC for a large company?
There is no universal number, since WACC depends on a company's risk, capital structure, and prevailing interest rates. Rather than memorize a figure, interviewers want you to explain the inputs and direction. Mature, low-risk companies generally have lower WACCs than small, volatile, high-growth firms.
How does WACC connect to enterprise value?
Discounting unlevered free cash flow at WACC yields enterprise value, because both the cash flow and the discount rate reflect all capital providers. You then bridge from enterprise value to equity value by subtracting net debt, as explained in enterprise value vs equity value.
Sources
- Corporate Finance Institute, "WACC Formula, Definition and Uses": https://corporatefinanceinstitute.com/resources/valuation/what-is-wacc-formula/ (checked June 2026)
- Wall Street Prep, "WACC Guide": https://www.wallstreetprep.com/knowledge/wacc/ (checked June 2026)
- Investopedia, "Weighted Average Cost of Capital (WACC)": https://www.investopedia.com/terms/w/wacc.asp (checked June 2026)
- Corporate Finance Institute, "Capital Asset Pricing Model (CAPM)": https://corporatefinanceinstitute.com/resources/valuation/capital-asset-pricing-model-capm/ (checked June 2026)