A company is financed by some mix of equity and debt, and each has its own cost. WACC blends the two into a single rate — the minimum return a company’s investments need to clear to be worth doing at all.
How it works
Equity and debt are weighted by their share of total capital (E/V and D/V, where V = E + D), then combined: (E/V × cost of equity) + (D/V × after-tax cost of debt). Debt’s cost is reduced by (1 − tax rate) because interest payments are tax-deductible in a way that returns paid to equity holders are not — the same dollar of debt cost is cheaper to a taxed company than the same dollar of equity cost.
Why the tax adjustment matters
At a 21% corporate tax rate, a 6% cost of debt behaves like 4.74% after the tax shield — roughly a fifth cheaper than its stated rate. Skipping that adjustment overstates what debt actually costs a company and understates how much cheaper debt financing is relative to equity, which is the entire reason companies use any debt at all rather than financing everything with equity.
What this does not include
This assumes single, constant figures for cost of equity and cost of debt — a real company often has several debt instruments at different rates and a cost of equity that itself needs a separate estimate, commonly from a model like this site’s CAPM calculator. It also doesn’t account for financial distress costs that can rise sharply at very high debt levels, which is one reason “more debt is always cheaper” isn’t true without limit even though this formula’s tax shield term keeps pointing that direction.
How to use this calculator
- Enter the market value of equity and of debt — use this site’s CAPM calculator first if you need to estimate the cost of equity.
- Enter the pre-tax cost of debt (the interest rate the company actually pays) and the corporate tax rate.
- The calculator weights both by their share of total capital and blends them into the WACC.
Frequently asked questions
What is WACC actually used for?
Most commonly as the discount rate in a discounted-cash-flow valuation, or as the hurdle rate a proposed project’s expected return has to beat to be worth funding.
Why is debt’s cost reduced by the tax rate but equity’s isn’t?
Interest paid to debt holders is deductible against taxable income, effectively subsidizing part of it; dividends and other returns paid to equity holders are not deductible in the same way, so no equivalent adjustment applies to the cost of equity.
What happens to WACC for a company with no debt?
The debt weight is zero, so WACC equals the cost of equity exactly — the tax rate plays no role at all, since there’s no debt cost left to shield.
Where does the cost of equity come from?
It’s usually estimated separately, commonly with the Capital Asset Pricing Model (CAPM) — this site has a dedicated CAPM calculator whose output is meant to feed directly into this one’s cost-of-equity field.
