WACC calculator

A private company financed 70% by equity and 30% by debt, with a comparable-company beta of 0.90 relevered to 1.19, a 5% equity risk premium, a 3% size premium and a 2% company-specific premium, has a cost of equity of 15.15% and a WACC of 12.40%. Build the equity cost up without a beta and the WACC is 11.74%. Use book equity for the weights and it is 10.16%, which is 2.24 points too low. What moves the answer most is not the capital structure but the premiums: letting the company-specific premium range from 0% to 4% moves WACC from 11.00% to 13.80%, while a 10-point move in the debt weight either way spans only 0.4 points.

The calculator handles a company with no stock price. It relevers a comparable beta, computes the cost of equity two ways, compares market and book weights, shows what each input can move the rate, and puts a value on a point of WACC.

Who reaches for this

Every WACC calculator uses this formula. What differs is how the inputs are found. Most tools assume a listed company with a share price and a beta of its own. A small private company has neither, so the calculator takes the beta of comparable public companies, removes their debt effect, and relevers it at your own debt-to-equity ratio. It then adds a size premium and a company-specific premium. As a cross-check, it computes the cost of equity again without a beta, by building up from the risk-free rate and the risk premium.

The result is a discount rate for the company’s free cash flows and a starting point for a hurdle rate on new projects. To see how a rate turns cash flows into a value, see the present value calculator, and for valuing a smaller owner-run business on earnings rather than discounted cash flows, the business valuation calculator.

Equity has no interest rate, so its cost is the return owners require for the risk they carry. The standard estimate is the capital asset pricing model: the risk-free rate plus beta times the equity risk premium. It was built for listed companies, and using it for a private one takes three adjustments.

Borrow a beta and relever it

A private company has no share price to compute a beta from. The usual solution is to use the betas of comparable public companies. A comparable’s beta reflects its own debt, so it is unlevered first, removing the effect of leverage, averaged if there are several, and then relevered at the private company’s debt-to-equity ratio. The common formula is levered beta = unlevered beta × (1 + (1 − tax rate) × D/E).

With an unlevered beta of 0.90, debt of $3.0 million and equity of $7.0 million, debt to equity is 42.9%. At a 25% tax rate the relevered beta is 0.90 × (1 + 0.75 × 0.429) = 1.19. The company is riskier for its owners than an all-equity version of itself, because the lenders are paid first.

Add a size premium

CAPM was calibrated mostly on large listed companies. Small companies have historically returned more than the model predicts for their betas, and valuers add a size premium to reflect it. Published size premiums come from data providers and depend on the size band. The example uses 3.0% as an illustration, and you should use a figure from a source you can cite for a company of your size.

Add a company-specific premium, with care

A company-specific premium covers risks that neither beta nor size captures: a founder who holds all the customer relationships, one customer that provides half the revenue, a thin management team, a short operating history. One advisory guide says 1% to 6% is commonly added. I could not trace that to a source, and it is the most subjective input on the page. It is also the most powerful: in the example, moving it from 0% to 4% takes WACC from 11.00% to 13.80%. Write down what each point is paying for.

The build-up route

Some valuers skip the beta and build the cost of equity from the risk-free rate, the equity risk premium, a size premium and a company-specific premium. It is equivalent to a beta of one. In the example it gives 4.2% + 5.0% + 3.0% + 2.0% = 14.2%, against 15.15% on the CAPM route, and a WACC of 11.74% against 12.40%. The gap is the effect of the 1.19 beta on the 5% premium. Two routes that disagree by 0.66 points are a useful check on how much the beta is doing.

Debt is priced at what the company would pay to borrow today, not at the rate on old loans. Use the current rate on the company’s debt, or what a lender would quote for new borrowing of the same size and risk. A coupon or a rate from years ago describes the past.

Interest is deductible, so the after-tax cost is the rate times one minus the tax rate. At 8% and 25%, it is 6.0%. The tax rate that belongs here is the marginal rate the company pays on the next dollar of income, not the average rate on all of it, since the deduction saves tax at the margin. For a C corporation that is the federal rate plus state tax. For a pass-through business, the owners’ rates apply. The 25% in the example is a blended illustration.

The tax shield is real only if the company pays tax and can deduct the interest. A company with losses gets no benefit until it has income, and larger companies may face limits on how much interest is deductible, such as the rules under section 163(j), which generally cap the deduction relative to adjusted taxable income and exempt smaller businesses under a gross-receipts threshold. Check the current rules for your company. In the example, the deduction is worth 0.60 points of WACC: without it the rate would be 13.00%.

The formula weights each cost by its share of total capital, and which values you use for the shares is where many WACC calculations go wrong. Three choices are common.

Book equity is what owners paid in plus retained earnings, an accounting record of the past. Market equity is what the ownership is worth now. In the example, the two differ by a factor of nearly three, and the book weights make debt look like more than half the capital and pull the WACC 2.24 points below the market-weighted figure. It is the most common way to get a WACC that is too low. Debt is easier, since book and market value are usually close for a company’s bank debt.

A private company’s equity value

For a private company there is no market price, and the equity value is what you are trying to estimate, which makes the calculation circular: the WACC needs the equity value and the equity value needs the WACC. The usual solutions are to use a target capital structure, based on comparable companies or the financing the company expects to use over time, or to iterate: guess a value, compute the WACC, discount, and repeat until they agree. The calculator lets you enter a target debt share for that reason.

A target structure has an advantage beyond avoiding circularity. It measures the company’s cost of capital at the mix of financing it would sustain, and not at the accidents of its current balance sheet. A business that has borrowed heavily this year to fund one purchase does not have a permanently lower cost of capital because of it.

A profitable private company with an estimated equity value of $7,000,000 and $3,000,000 of debt. The inputs are illustrations and are not current market data.

Equity contributes 10.60 points and debt 1.80. Equity is 70% of the capital and provides 85% of the cost, because it is expensive: 15.15% against 6.0% for debt. That is why the mix matters at all, and why a borrowed dollar seems cheap. Whether it really is is the subject of the debt section below.

Most of the discussion of WACC is about the formula and the weights. The larger effects are elsewhere. The table moves each input by a reasonable amount, holding the rest fixed, and shows the range of WACC.

The swing is the distance between the two ends of each range, and the ranking is the useful part. The inputs that describe the cost of equity, the premiums, the beta and the risk-free rate, each move the answer by 1.4 to 2.8 points. The cost of debt moves it by 0.45 points, and the capital structure by 0.42. A valuer who spends a day debating whether the debt weight is 30% or 35% and a minute on the company-specific premium has the effort the wrong way round.

Two conclusions follow. First, the answer is an estimate with a plausible range of a few points, and it should be presented as one. A WACC quoted to two decimals conveys a precision the inputs do not have. Second, the inputs with the most effect are the ones you can least verify, which is why documenting them matters. A reader can disagree with a premium, and the calculation can show what the disagreement costs.

Debt looks cheap in the formula: 6.0% after tax against 15.15% for equity. If borrowing were free of side effects, a company would borrow until equity disappeared. It is not, for two reasons. Debt raises the risk borne by the remaining equity, so the cost of equity rises with leverage, which the relevered beta captures. And lenders charge more as a company borrows more. What is left after the first effect is mostly the tax shield, and the second eventually outweighs it.

Here the cost of debt rises by one point for every ten points of added debt weight, an assumption you set. The WACC falls from 13.70% with no debt to a low of 12.27% at 40%, and then rises. Moving from 30% to 40% debt gains only 0.13 points. The curve is flat near its bottom, and that flatness is the real lesson: once a company has a reasonable amount of debt, the exact mix matters little for WACC, and the other inputs matter far more.

Where the minimum falls depends entirely on the step. With half a point per ten points, the lowest rate is at 70% debt. With two points, it is at 30%. Real lenders do not follow a straight line, and for a small company the constraint is often the lender’s appetite and covenants, not a smooth price. Treat the table as an illustration of the trade-off, and not as a target. It also ignores the costs of financial distress, which make high leverage worse than the arithmetic suggests.

A discount rate turns future cash flows into a value, and small changes in the rate make large changes in the value. Take a business expected to generate $800,000 of free cash flow next year, growing 3% a year indefinitely. A growing perpetuity is worth next year’s cash flow divided by the rate less the growth: $800,000 ÷ (12.40% − 3%) = $8,508,375.

One point of WACC is worth about 10% of the business. That is why the premiums matter so much: letting the company-specific premium run from 0% to 4% moves WACC by 2.8 points, which puts this business anywhere from $7.4 million to $10.0 million. It is also why a valuation should show a range and not a point. The sensitivity table on the calculator gives the range of WACC, and the value changes with it.

The perpetuity is an illustration. A real valuation projects several years of cash flow and adds a terminal value, and the terminal value is again a growing perpetuity, so the same sensitivity applies. The present value calculator shows the discounting step by step.

A hurdle rate is the minimum return a project must earn to be worth doing. Many companies use WACC as the hurdle for projects that resemble the existing business, since it is the return that keeps lenders and owners whole. A project that returns less than WACC destroys value, and one that returns more creates it.

A project that is riskier than the business should face a higher rate, and one that is safer, a lower one. A company-wide WACC applied to every project makes the safe ones look worse than they are and the risky ones better. Take a $500,000 investment that returns $145,000 a year for five years, an internal rate of return of 13.8%. At the company’s 12.40% WACC, its net present value is about +$17,500 and it clears. If it is a new market and deserves a 2-point risk premium, the hurdle is 14.4%, the NPV is about −$7,000, and the decision reverses. The rate, not the cash flows, made the difference.

For a small company, a project’s hurdle should also reflect what the owner could earn on the money elsewhere, and the owner’s appetite for risk. WACC is a market-based starting point, and it is a good discipline: it forces the question of what the capital costs before it is spent.

The calculator’s starting values are illustrations. Market data changes daily and each input has a natural source, so I have not stated current figures. Here is where to look.

Record the date and source of each input next to the result. A WACC without its inputs is a number no one can check, and one with them can be updated in an hour when rates move.

See how a rate turns into a value with the present value calculator, or build a full multi-year valuation with the DCF calculator.