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Corporate Finance & Valuation

How to Calculate WACC & CAPM: Weighted Cost of Capital Step-by-Step

12 min read • Updated 2026-11-03 • Mathematically Verified

The Weighted Average Cost of Capital (WACC) is the hurdle rate used to evaluate corporate capital investments and discount cash flows in DCF models. This guide explains how to blend equity and debt capital, apply the Capital Asset Pricing Model (CAPM), and account for corporate tax shields.

1. The Universal WACC Formula

WACC represents the blended cost an organization pays to finance its assets through a combination of common equity, preferred equity, and interest-bearing debt:

WACC = (E / V) × r_e + (D / V) × r_d × (1 - t) + (P / V) × r_p

Where:
E = Market Value of Equity (Market Capitalization)
D = Market Value of Debt
P = Market Value of Preferred Stock
V = Total Firm Capital = E + D + P
r_e = Cost of Equity
r_d = Pre-Tax Cost of Debt (Yield to Maturity on Bonds)
t = Marginal Corporate Income Tax Rate
r_p = Cost of Preferred Stock

2. Estimating Cost of Equity with CAPM

Because equity capital does not have a contractual interest coupon, its cost represents the opportunity cost required by common shareholders to compensate for market risk:

r_e = r_f + β × (r_m - r_f) = r_f + β × ERP

r_f = Risk-Free Rate (typically the yield on 10-year or 30-year US Treasury bonds)
β = Equity Beta (sensitivity of stock returns relative to broader market index)
ERP = Equity Risk Premium (r_m - r_f, historically 4.5% - 6.0%)

3. The Interest Tax Shield on Debt

Unlike equity dividend payments, debt interest is tax-deductible in most jurisdictions. The effective economic cost of debt is therefore reduced by the corporate marginal tax rate: r_d × (1 - t).

Step-by-Step Corporate WACC Calculation

A manufacturing corporation has the following capital parameters:

  • Capital Structure: Market Cap (E) = $600M • Total Debt (D) = $400M • Total Capital (V) = $1,000M
  • Capital Weights: E/V = 60.0% • D/V = 40.0%
  • Cost of Debt Inputs: Pre-Tax Cost of Debt (r_d) = 6.5% • Corporate Tax Rate (t) = 25.0%
    After-Tax Cost of Debt = 6.5% × (1 - 0.25) = 4.875%
  • CAPM Cost of Equity Inputs: Risk-Free Rate (r_f) = 4.2% • Beta (β) = 1.20 • Equity Risk Premium = 5.0%
    Cost of Equity (r_e) = 4.2% + (1.20 × 5.0%) = 4.2% + 6.0% = 10.20%
  • Final WACC Calculation:
    WACC = (0.60 × 10.20%) + (0.40 × 4.875%)
    WACC = 6.12% + 1.95% = 8.07%

Frequently Asked Questions

Should book value or market value be used for debt and equity weights?

Always use market values. Book value represents historical accounting costs, whereas WACC measures the expected cost of raising new marginal capital in modern financial markets today.

What is the Hamada Equation for un-levering Beta?

The Hamada equation removes the effect of financial debt leverage to isolate pure business operational risk: β_unlevered = β_levered / [1 + (1 - t) × (D / E)]. This allows analysts to compare peer betas across different capital structures.

Technical Reference Notice: This article is published for educational and engineering reference purposes. Numerical calculations should be verified independently against manufacturer specifications, local regulatory codes, and company standards before making operational, financial, or safety-critical decisions.