WACC, or weighted average cost of capital, is the blended rate of return a company must earn to satisfy all its investors. It averages the cost of equity and the after-tax cost of debt, weighting each by its share of the company's total financing. WACC is the discount rate most analysts use to value a business in a discounted cash flow model.
Worked example
A company is 70% equity-financed and 30% debt-financed. Its cost of equity is 9%, its pre-tax cost of debt is 5%, and its tax rate is 25%. WACC = (0.70 × 9%) + (0.30 × 5% × (1 − 0.25)) = 6.3% + 1.125% = 7.43%.
Why it matters
WACC is the hurdle rate for investment decisions: a project that returns less than WACC destroys value. It is also the standard discount rate in a DCF valuation, so a small change in WACC can move an estimated fair value substantially.
Frequently asked questions
A lower WACC is generally better for a company — it means cheaper financing and a higher present value of future cash flows. For an investor discounting cash flows, a higher WACC produces a more conservative valuation.
Most large, stable companies sit somewhere between roughly 6% and 10%, but WACC varies widely with interest rates, leverage and business risk, so it should always be calculated from current inputs.