The WACC formula or weighted average cost of capital formula is used to take the weighting of both equity and debt into account to arrive at an average cost of capital funding for the business.

A business normally uses both equity and debt to provide capital funding. Consequently the cost of capital is therefore a combination of the cost of equity and the cost of debt. The overall cost of capital for the business will change depending on how much weighting each type of capital has.

Accordingly the WACC formula can be stated as follows:

**Variables used in the formula**

Cost of equity = % rate of return on equity

Cost of debt = % cost of debt

E = market value of the equity of the business

D = market value of the debt of the business

E/(E+D) = % of capital funded by equity

D/(E+D) = % of capital funded by debt

Tax rate = % tax rate

## WACC Formula Example

As an illustration, suppose a business is 75% funded by equity and 25% funded by debt, and the rate of return on equity of the business is 15%, the cost of debt is 6%, and the tax rate is 30%.

In this situation the WACC formula can be used to give the weighted average cost of capital as follows:

Cost of equity = 15% Cost of debt = 6% Percentage of equity = E/(E+D) = 75% Percentage of debt = D/(E+D) = 25% Tax rate = 30% WACC = Cost of equity x E/(E+D) + Cost of debt x (1-tax rate) x D/(E+D) WACC = 15% x 75% + 6% x (1-30%) x 25% WACC = 12.30%

As can be seen the WACC formula shows that the weighted average cost of capital for the business is 12.30%. this value can be used for example, as the discount rate when carrying out project valuations using the net present value method, such as that used in our freemium model calculator.

## WACC and Debt Equity Ratio

The formula for WACC above can be rearranged to express the weighted average cost of capital in terms of the debt equity ratio as follows.

**Variables used in the formula**

Cost of equity = % rate of return on equity

Cost of debt = % cost of debt

D/E = Debt equity ratio

Tax rate = % tax rate

Or alternatively to express the debt equity ratio.

## WACC Debt Equity Formula Example

As an illustration, suppose a business has a debt equity ratio of 0.65, and the rate of return on equity of the business is 12.1%, the cost of debt is 5.5%, and the tax rate is 30%.

In this situation the WACC Debt Equity formula can be used to give the weighted average cost of capital as follows:

Cost of equity = 12.1% Cost of debt = 5.5% Debt equity ratio = 0.65 Tax rate = 30% WACC = Cost of equity x 1/(1+D/E) + Cost of debt x (1-tax rate) x (D/E)/(1+D/E) WACC = 12.1% x 1 / (1+0.65) + 5.5% x (1-30%) x 0.65 / (1+0.65) WACC = 8.85%

## About the Author

Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.