The discount rate must match the cash flow.
WACC blends the required return on equity with the after-tax marginal cost of debt, using market-value financing weights. This debt-and-equity convention is intended for free cash flow to the firm. Cash flow to equity instead requires an equity discount rate.
CAPM is an optional way to articulate a cost-of-equity assumption: risk-free rate plus levered equity beta times an equity risk premium. Private-company beta, illiquidity and country risk are not inferred here. A loss-making company may be unable to use interest deductions; enter a zero usable tax shield when appropriate.
The formula, made clear.
- Weights
- Market-value target debt and equity proportions total 100%; no preferred stock or hybrid debt.
- Tax shield
- An assumed usable benefit, not automatic tax deductibility.
- CAPM inputs
- All assumptions are supplied by the user; inactive direct/CAPM inputs do not affect WACC.
Put the numbers in context.
At a direct 15% equity cost, 8% debt cost, 25% usable tax shield and 20% debt weight, WACC is 15% × 80% + 8% × 75% × 20% = 13.2%. The separate CAPM estimate is 4% + 1.2 × 5% = 10%.
| Input | Example value |
|---|---|
| Cost of equity convention | Direct cost of equity |
| Direct cost of equity | 15% |
| Risk-free rate | 4% |
| Levered equity beta | 1.2 × |
| Equity risk premium | 5% |
| Pre-tax marginal cost of debt | 8% |
| Usable interest tax-shield rate | 25% |
| Debt share of capital | 20% |
| Weighted average cost of capital | 13.2% |
What this calculation assumes
Two sources of capital, fixed target market-value weights and annual nominal rates consistently matched to cash-flow currency and inflation. No market data, preferred equity, tax-law analysis or inferred private-company beta. Negative or zero discount rates can be calculated here but may not be accepted by the DCF model.
Methodology references
What to consider next.
Review the assumptions behind the equity rate and tax shield, then transfer WACC to DCF and examine sensitivity to both discount rate and terminal growth.
How we approach financial models →