What is WACC, the Weight Average Cost of Capital?

by Girl Banker 

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WACC represents the combined cost of debt and equity   

The free cash flows in Discounted Cash Flow (DCF) Analysis are normally discounted using the weighted average cost of capital, WACC.

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Where:

• r(d) is the average cost of debt 
• r(e) is the cost of equity 
• Debt / (Debt + Equity) is the proportion of debt in the business
• Equity / (Debt + Equity) is the proportion of equity in the business

r(d)(1 - company's tax rate) is the post tax cost of debt.

E.g. If:

• r(d) = 6.25%
• r(e) = 5.58%
• Debt / (Debt + Equity) = 47%
• Equity / (Debt + Equity) = 53%
• Tax rate = 30%
• WACC = 6.25% x (1 - 30%) x 47% + 5.58% x 53% = 5.02%

You simply can't go to a corporate finance or asset management interview without knowing this formula. It is basic and fundamental.

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