The weighted average cost of capital (WACC) is the average return a company must pay its investors, weighted by the market values of equity and debt. Calculate the cost of equity, often with CAPM, and the after-tax cost of debt, then weight each by its share of total market value and add them together.
| Step | Formula or method |
|---|
| Cost of equity | CAPM: Ke = Rf + β(Rm − Rf) |
| After-tax cost of debt | Kd × (1 − tax rate) |
| Weights | Market value of equity and debt ÷ total market value |
| WACC | (E/V × Ke) + (D/V × Kd after tax) |
Worked example: with a risk-free rate of 4%, a beta of 1.2 and a market risk premium of 5%, CAPM gives a cost of equity of 4% + 1.2 × 5% = 10%. If equity is 60% and debt 40% of total market value, the pre-tax cost of debt is 6% and the UK corporation tax main rate is 25% (from April 2023):
| Component | Calculation | Result |
|---|
| Cost of equity (CAPM) | 4% + 1.2 × 5% | 10.0% |
| After-tax cost of debt | 6% × (1 − 0.25) | 4.5% |
| Weighted equity | 0.6 × 10% | 6.0% |
| Weighted debt | 0.4 × 4.5% | 1.8% |
| WACC | 6.0% + 1.8% | 7.8% |
Check current rates on GOV.UK corporation tax rates, and use Bank of England data or gilt yields when choosing a UK risk-free rate.