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Finance · level 2

WACC

A weighted mean where only the debt side gets the tax shield. Do the after-tax debt cost first, then blend — it keeps the weighting arithmetic clean.

Theory: Corporate Finance

Worked example: 50% debt at 6%, equity at 12%, tax 20%. WACC?

equity leg6%
debt leg2.4%
WACC8.4%

Step by step

  1. 1

    WACC

    E/V × rₑ + D/V × r_d × (1 − t)

  2. 2

    Equity leg

    50% × 12% = 6%

  3. 3

    After-tax debt cost

    6% × (1 − 20%) = 4.8%

  4. 4

    Debt leg

    50% × 4.8% = 2.4%

  5. 5

    Add

    8.4%

50% debt at 6%, equity at 12%, tax 20%. WACC? = 8.4

The theory behind it

Intuition

WACC is a weighted average of what debt and equity holders each require, with debt cheapened by the tax shield.

Common pitfalls

  • ×Weighting by book rather than market values.
  • ×Forgetting (1 − t) on the cost of debt.

In the interview

The discount rate you must justify before any DCF number is credible.