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DCF

WACC, explained

By SuperdayReps · Wharton MBA · ex-Greenhill · investment banking interview coaching

6 min read · updated July 2, 2026

Every dollar of capital a company uses has a price. Lenders want interest. Equity holders want a return that pays them for the risk of owning the stock. The weighted average cost of capital (WACC) is just those two prices blended by how much of each the company uses. That's it.

Why should you care before you can compute it? Because WACC is the rate you discount cash flows at in a DCF, and the output of a DCF is brutally sensitive to it. Move WACC by one point and the valuation can swing 15% or more. So the number isn't a formality. It's half the model.

The formula

WACC=EV re+DV rd (1−t)\text{WACC} = \frac{E}{V}\,r_e + \frac{D}{V}\,r_d\,(1-t)

Read it left to right. EE is the market value of equity, DD is the market value of debt, and V=E+DV = E + D is the whole thing. So E/VE/V and D/VD/V are just the weights: what fraction of the company's financing comes from stock versus loans. Then you multiply each weight by that source's cost. rer_e is the cost of equity, rdr_d is the cost of debt, and tt is the tax rate.

Two pieces need unpacking: the weights and that (1−t)(1-t) on the debt term. Get those wrong and the whole thing is off.

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Frequently asked

What is WACC?
WACC, the weighted average cost of capital, is the blended return debt and equity holders demand, weighted by how much of each the company uses. It is the rate you discount unlevered cash flows at in a DCF. The output is brutally sensitive to it, since moving WACC one point can swing the valuation 15 percent or more.
What is the WACC formula?
WACC equals the equity weight times the cost of equity, plus the debt weight times the after-tax cost of debt. The weights are market values, equity is market cap and debt is its market value, over total capital. The debt term carries a one minus tax rate factor because interest is tax-deductible.
Why is the cost of debt after-tax in WACC?
Because interest expense is tax-deductible, so it lowers the tax bill. That saving is the tax shield, and it makes debt cheaper than its stated rate. Borrow at 10 percent with a 20 percent tax rate and the real cost is 10 percent times one minus 0.20, or 8 percent. Equity gets no such break.
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