The weighted average cost of capital is the blended return a company must earn to satisfy everyone who funds it — both lenders and shareholders. It weights the cost of each source of capital by how much of the financing it provides, giving a single percentage that represents the company’s overall cost of money.
In valuation, WACC is the discount rate: the rate used to shrink future cash flows back to what they are worth today. A higher WACC means future cash is discounted more heavily, and the business is worth less now.
E = market value of equity, D = market value of debt, V = E + D, Re = cost of equity, Rd = cost of debt, Tc = corporate tax rate. The (1 − Tc) term reflects that interest is tax-deductible.
Suppose a company is financed with $6,000M of equity at a 9% cost of equity and $4,000M of debt at a 5% cost of debt, with a 21% tax rate. Equity is 60% of the total and debt 40%:
Roughly 7% is the hurdle this company’s investments must clear to create value — and the rate you would discount its projected cash flows at in a DCF.
Treat WACC as the hurdle rate: projects and returns above it create value for owners, while those below it destroy it. In a discounted-cash-flow model it is the discount rate applied to every projected year and to the terminal value.
In our own Advanced DCF you do not type a WACC in: the model builds one, and what is editable are the five inputs it is built from: the risk-free rate (the 10-year US Treasury yield), the company’s beta, the market risk premium, its cost of debt, and the tax rate at which that interest is deducted. Cost of equity is rf + β × MRP; the two are then weighted by debt and market capitalisation. Move any one of them and the rate — and the value — moves with it.
Because valuations are highly sensitive to it, it is worth testing a range of assumptions rather than trusting a single point estimate. The other three methods on the Intrinsic Value tab sidestep the question: Graham’s formula has no discount rate at all, and the two growing series take one flat rate you choose yourself rather than one derived from the company’s capital structure.
WACC is central to intrinsic valuation and to capital-allocation decisions — whether to take on a project, issue debt, or buy back stock. Any DCF-based estimate of fair value rests on it.
The cost of equity cannot be observed directly — it is estimated, usually via CAPM, which makes WACC sensitive to inputs like beta and the equity risk premium. It also assumes a stable capital structure, and small changes in the rate swing valuations substantially. Precise-looking WACC figures carry real uncertainty. It is also the bar a company’s return on capital has to clear to count towards an economic moat.