WACC
Weighted Average Cost of Capital
The minimum return a company must generate to satisfy all its capital providers.
What it is
WACC is the discount rate used in a DCF model. It combines the cost of equity and the cost of debt (borrowed capital), weighted by their respective shares in the company's capital structure.
WACC = (E/V) × Ke + (D/V) × Kd × (1 − tax)
- →E = market value of equity
- →D = market value of debt
- →V = E + D
- →Ke = cost of equity (CAPM: Rf + β × ERP)
- →Kd = cost of debt (pre-tax)
Typical WACC range: 7–12% for large companies, higher for riskier firms.
Why track it
WACC is the "hurdle rate" — the minimum return on invested capital. A company whose ROIC consistently exceeds WACC creates economic value. A company with ROIC below WACC destroys it.
A higher risk-free rate (interest rates) raises WACC → lowers the fair valuation of all assets. Higher rates = lower equity valuations.
Real-world example
Microsoft WACC ~9%: Rf = 4.4% (US 10Y Treasury), Beta = 0.9, ERP = 5.25% → Ke ≈ 9.1%. Minimal debt → WACC ≈ 8.8–9.0%.
Microsoft ROIC ~32% >> WACC 9% → the company creates enormous economic value.