How do you calculate the WACC?
What the interviewer is testing
The formula, and the choices behind each input.
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Show the model answer
WACC is the average return required by all the company's capital providers, weighted by their share of capital at market values: cost of equity × equity weight plus after-tax cost of debt × debt weight. Cost of equity comes from CAPM; cost of debt is the rate the company would pay to borrow today, after tax. Use a target or optimal capital structure, not just today's.
The full answer
WACC = E/(D+E) × Ke + D/(D+E) × Kd × (1 − t)
Example
| Input | Value |
|---|---|
| Risk-free rate | 3.0% |
| Equity risk premium | 5.0% |
| Levered beta | 1.1 |
| Cost of equity (3% + 1.1 × 5%) | 8.5% |
| Pre-tax cost of debt | 5.0% |
| Tax rate | 25% |
| After-tax cost of debt | 3.75% |
| Debt / (debt + equity) | 30% |
| WACC (70% × 8.5% + 30% × 3.75%) | 7.08% |
Choices that matter
- Weights: target structure at market values (peers' median, or management's target).
- Cost of debt: current yield on the company's bonds or new-issue spreads for its rating — not the coupon on old debt.
- Currency: the risk-free rate in the currency of the cash flows.
- Preferred shares, if any, get their own weight and cost.
Mistakes to avoid
Using book values of equity for the weights.
Forgetting the tax shield on debt.
Follow-ups they may ask
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