Chapter 9 — Weighted Average Cost of Capital (WACC)

FIN301 Interactive

1) What is WACC?

WACC is the firm’s blended required return on the capital it uses to fund core operating assets. It averages the cost of equity, debt, and, if any, preferred stock, weighted by their market values.

Plain English: projects earning more than WACC create value; projects below WACC destroy value.

2) Why does WACC matter?

  • Hurdle rate for NPV and IRR decisions.
  • Discount rate for FCFF valuation.
  • Performance yardstick using ROIC − WACC.
  • Capital-structure trade-off between tax shields and risk.

3) Start here: game + calculator

These are the two most important interactive tools on this page. Start with the game for intuition, then use the calculator for the numbers.

Start here first

🎮 WACC Interactive Game

Use the game to practice how debt, equity, taxes, and the cost of capital fit together. This is a quick way to build intuition before doing calculations.

Open the WACC Game ↗
Main calculation tool

📊 WACC Calculator

Use this calculator for annual bonds, semiannual bonds, coupon rate and bond yield inputs, dividend-discount inputs, and CAPM-based cost of equity.

Open the WACC Calculator ↗
Best order: watch the short video, try the game, then use the calculator and the in-class exercises below.
Jump to in-class exercises Jump to chapter calculator section

5) Master formula

Market-value weights
After-tax debt
Project discount rate
WACC = (D / (D + E)) * Kd_after_tax + (E / (D + E)) * Ke where: D = market value of debt E = market value of equity Kd_after_tax = Kd * (1 - TaxRate) Ke = cost of equity (CAPM or Dividend Discount Model)
Reminder: Use market values for weights. The debt term in WACC is after-tax because interest expense creates a tax shield.

6) Cost of debt (Kd): bond yield, then after-tax

Bond input
Kd_before_tax = RATE(nper, coupon_rate*1000, -(price - flotation_costs), 1000) Kd_after_tax = Kd_before_tax * (1 - tax_rate)
Bond input
Kd_before_tax = RATE(nper*2, coupon_rate*1000/2, -(price - flotation_costs), 1000) * 2 Kd_after_tax = Kd_before_tax * (1 - tax_rate)
Flotation costs: flotation_costs = flotation_percent × price. Use price − flotation_costs as the net proceeds.

7) Cost of equity (Ke): CAPM or Dividend Discount Model (DDM)

Method Formula When to use
CAPM (beta given)
1 CAPM (Cost of Equity)
Ke = rRF + β * (Rm - rRF) Ke = rRF + β * MRP
 When beta and a market risk premium assumption are available.
DDM (dividend given)
2 Dividend Discount Model (DDM)
Ke = D1 / (P0 - flotation_costs) + g flotation_costs = flotation_percent * P0
 Dividend-paying firms with stable growth assumptions.

8) Excel pricing toolbox

CouponRate means the bond's annual coupon rate in decimal form. Example: an 8% coupon means CouponRate = 0.08.

Bond price (annual)
Price = ABS( PV(YTM, YearsToMaturity, CouponRate*1000, 1000) )
YTM (annual)
YTM = RATE(YearsToMaturity, CouponRate*1000, -Price, 1000)
Bond price (semiannual)
Price = ABS( PV(YTM/2, YearsToMaturity*2, CouponRate*1000/2, 1000) )
YTM (semiannual)
YTM = RATE(YearsToMaturity*2, CouponRate*1000/2, -Price, 1000) * 2

9) In-class exercises (FIN435-style)

Reminder: these are practice examples only. There is no homework, no quiz, and this part is not on the final exam.
Exercise 1 — IBM WACC ▾
Question
Debt: $10m, coupon rate 5%, 10 years, price $950, flotation 7% of price, tax 40%. Equity: $20m, D1 = $5, P0 = 50, g = 5%, flotation = 0. Task: Compute IBM’s WACC.
Show solution ▾
Answer (structure): Wd = 1/3, We = 2/3 Kd = RATE(10, 5%*1000, -(950 - 950*7%), 1000) * (1-40%) = 3.98% Ke = 5/(50-0) + 5% = 15.00% WACC = (1/3)*3.98% + (2/3)*15.00% = 11.33%
Exercise 2 — After-tax cost of debt (semiannual) ▾
Question
Noncallable bond, 20 years to maturity, 9.25% annual coupon paid semiannually, price = 1075, par = 1000, tax = 40%. Find the after-tax cost of debt.
Show solution ▾
After-tax Kd = RATE(20*2, 9.25%*1000/2, -1075, 1000) * (1-40%) = 5.08%
Exercise 3 — Cost of equity (DDM with flotation) ▾
Question
D1 = 1.25, P0 = 27.50, g = 5.00%, flotation = 6% of price. Find the cost of equity.
Show solution ▾
Ke = 1.25 / (27.5 - 0.06*27.5) + 5% = 9.84%
Exercise 4 — WACC from weights ▾
Question
Total capital raised: $10m, debt $3m, equity $7m. Set up the WACC formula from the financing weights.
Show solution ▾
Wd = 3/10 We = 7/10 WACC = (3/10)*Kd + (7/10)*Ke

10) WACC calculator & company presets

This keeps the FIN509 calculator structure and presets.

Main WACC tool

Use the full JUFinance WACC Calculator

This is the main external calculator for bond-based cost of debt, CAPM, and dividend-discount cost of equity.

Open the WACC Calculator ↗

Capital structure (market values)

Costs & tax

Weights: —

Presets (illustrative)

After loading, click Compute WACC. The detailed math appears below.

11) Damodaran + Interactive 4D chart

Use this to compare typical WACC, cost of equity, and leverage across industries. This is useful for sanity-checking project discount rates.

Industry reference

Damodaran — Cost of Capital by Sector (US)

Open the sector table to compare industry averages for beta, debt-to-equity, tax rate, cost of debt, cost of equity, and WACC.

Open Damodaran sector page ↗
Interactive visualization

Interactive 4D industry chart

Rotate the chart and hover over points to compare industries.

Open the 4D chart ↗
How to read it: x = D/E (%), y = Beta, z = WACC, color = Tax rate. Drag to rotate and hover for exact values.
Important: Keep this graph file in the same folder as the main FIN509 HTML file if you open it locally.

12) Company type ↔ debt & WACC

Company TypeDebt LevelWACC LevelReasoningExample
StartupLowHighHigh risk, limited cash flow → equity funding preferred.Early-stage tech startup
High-TechLow–ModerateHighHigh growth and risk, so firms avoid too much debt burden.Biotech firm
RetailModerate–HighModerateStable cash flows allow some leverage.Supermarket chain
UtilityHighLow–ModeratePredictable cash flows support heavy debt.Electric company
ManufacturingModerateModerateBalanced capital structures are common.Auto manufacturer
Mature firmHighLowStable and predictable cash flows usually lower WACC.Coca-Cola

15) Notes & extras

  • Assign: source beta, risk-free rate, market risk premium, YTM, and tax rate, then justify the choices.
  • Compare current structure versus target D/E.
  • Run ±1% sensitivity on RE and RD.

15) Quiz 1 — WACC Concepts 10 True/False

Topic focus: what WACC is, why it matters, and its main components.

Quiz focus

Use this quiz to check your understanding of the basic logic of WACC before working on formulas and calculations.

16) Quiz 2 — Kd, Ke, and Industry WACC 10 True/False

Topic focus: before-tax vs. after-tax Kd, CAPM and DDM for Ke, coupon rate and YTM, and industry differences in WACC.

Quiz focus

Use this quiz after reviewing bond yield, tax adjustment, CAPM, DDM, and why WACC can differ for high-tech versus retail firms.

Homework

No solution is shown here. Use In Class Exercise 1 as the reference for Homework 1, and use In Class Exercises 2–4 as the reference for Homework 2.
Homework 1 — Annual coupon bond + dividend growth model ▾
Question
A firm is financed with debt and equity. Debt: Market value of debt = $12 million Annual coupon rate = 6.0% Years to maturity = 12 Current bond price = $960 Flotation cost = 5% of price Tax rate = 35% Equity: Market value of equity = $24 million Expected dividend next year, D1 = $3.20 Current stock price, P0 = $40.00 Growth rate, g = 4.0% Flotation cost on equity = 0 Task: 1) Compute the before-tax cost of debt 2) Compute the after-tax cost of debt 3) Compute the cost of equity using the dividend growth model 4) Compute the firm’s WACC Reference: Use Exercise 1 on this chapter page as your guide.
Homework 2 — Semiannual bond + CAPM ▾
Question
A firm is financed with debt and equity. Debt: Market value of debt = $8 million Annual coupon rate = 8.5% Coupon payments are semiannual Years to maturity = 18 Current bond price = $1,040 Flotation cost = 4% of price Tax rate = 30% Equity: Market value of equity = $22 million Risk-free rate = 4.2% Beta = 1.15 Market risk premium = 5.8% Task: 1) Compute the before-tax cost of debt using semiannual bond inputs 2) Compute the after-tax cost of debt 3) Compute the cost of equity using CAPM 4) Compute the debt weight and equity weight 5) Compute the firm’s WACC Reference: Use Exercises 2–4 on this chapter page as your guide.