Weighted Average Cost of Capital (WACC)
- Arnold Shields
- Feb 16, 2011
- 2 min read
Updated: Jun 16
Weighted Average Cost of Capital (WACC) represents the average rate of return a company needs to generate to satisfy its capital providers, both debt holders and equity investors. It reflects the minimum return required to justify investment risk.
In other words, WACC is the cost of financing a business, taking into account both debt and equity in proportion to their market values.
The WACC Formula
WACC is calculated using the following formula:
WACC = (Kd × D / (D + E)) + (Ke × E / (D + E))
Where:
Kd = Cost of debt
Ke = Cost of equity
D = Market value of debt
E = Market value of equity
How to Determine Each Component
1. Cost of Debt (Kd)
Cost of debt is derived from financial statements and loan agreements. Since interest expenses are tax deductible, the after-tax cost of debt is generally used in WACC calculations.
2. Cost of Equity (Ke)
The cost of equity is typically calculated using the Capital Asset Pricing Model (CAPM):
Ke = Rf + β(Rm - Rf)
Where:
Rf = Risk-free rate (e.g. long-term government bond yield)
Rm - Rf = Market risk premium
β = Beta, a measure of the investment's volatility relative to the market
There are many academic studies and market analyses in Australia that provide guidance on appropriate market risk premiums and beta estimates.
The Practical Challenges of Calculating WACC
While the formula is straightforward, determining an accurate WACC involves professional judgement:
Comparative analysis may be needed when company-specific beta is unavailable
Adjusting beta to reflect forward-looking risk rather than past performance
Aligning time frames between discount rates and projected cash flows
Determining appropriate gearing, which may differ from current capital structure
These assumptions can vary significantly between valuers — particularly when estimating WACC for unlisted businesses or segments of a larger corporate group.
When WACC Doesn't Fit
Although WACC is widely used in valuing listed companies and in regulatory settings, it is less reliable for smaller, owner-managed businesses. Applying a market-based WACC to a private SME can result in unrealistic or even misleading valuations.
Understanding the context and making reasonable, well-informed adjustments is key.
Need Help Determining WACC for Your Business?
At Dolman Bateman, we specialise in valuation services tailored to both listed and private businesses. Our team brings the rigour needed to estimate a defensible WACC and apply it meaningfully in commercial and legal settings.
Contact us today to discuss how we can support your business valuation needs.
Disclaimer:
The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.
