What Is WACC? Formula, Calculation and Private Company Rates

What is WACC?

WACC — the weighted average cost of capital — is the blended annual return a company must earn to satisfy everyone funding it. It weights the cost of equity and the after-tax cost of debt by how much of each the company uses:

WACC = (E/V × Cost of Equity) + (D/V × Cost of Debt × (1 − Tax Rate))

where E is equity, D is debt, and V is E + D.

In a DCF it is the rate you discount future cash flows by. In capital allocation it is the floor a project has to clear. With the 10-year gilt at 5.29% and the 10-year Treasury at 4.94%, most private companies now land somewhere between 12% and 22% — and where inside that band you sit changes your valuation by more than any forecasting assumption you will argue about.

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Why the number matters more than the formula

The formula is arithmetic. The inputs are judgement, and the judgement is worth a great deal of money.

Take a business generating £10M of free cash flow, growing at 2.5% in perpetuity. Value it at a 14.2% WACC — derived below from today's gilt yield — and it is worth £85M. Value the identical cash flows at 10%, a rate that sounds reasonable and that plenty of founder-built models still carry, and it is worth £133M.

Same company, same forecast, same growth rate: a 56% difference in value from one input.

That is why the discount rate is the first thing a diligence team pressure-tests, and why "we used 10%" is not an answer. It is also why a DCF is only ever as defensible as its WACC derivation.

Value of £10M of free cash flow in perpetuity. A single percentage point of WACC moves the answer by roughly 7–10%.

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The formula, term by term

Two things people get wrong here before they reach the hard part.

Use market weights, not book weights. Book equity is an accounting residual with no relationship to what the equity is worth. If you are valuing the company, the weights should reflect the capital structure you are valuing it at.

Use a target structure, not the current one. A company that happens to carry no debt this quarter does not have a 100%-equity cost of capital forever. Use the structure the business will run at once it is mature — which is usually where its comparable set sits.

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Cost of debt: the easy half

Take the rate you would pay on new borrowing today, not the average rate on legacy facilities and not the coupon on a loan you took out when base rates were different. With gilts at 5.29%, a private mid-market borrower is realistically paying somewhere in the high single digits to low teens, depending on security and leverage. If you have current facilities priced at market, use them. If you do not, take the yield on debt of companies with a similar credit profile.

Then tax-affect it. At a 25% tax rate, debt costing 9.5% costs you 7.1% after the interest deduction.

The one trap: if your model already deducts interest before the cash flow you are discounting, you are counting the debt benefit twice. WACC discounts unlevered free cash flow — cash before financing. Discounting levered cash flow at WACC is one of the most common errors in a founder-built model, and it inflates the answer.

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Cost of equity: where the argument actually is

The standard starting point is the Capital Asset Pricing Model:

Cost of Equity = Risk-Free Rate + (Beta × Equity Risk Premium)

Where those two inputs stand today:

Both risk-free rates have risen materially over the past year — the gilt is up 57 basis points on twelve months ago. A WACC derived in 2023 and never revisited is not conservative. It is simply out of date, and every valuation built on it is too high.

Match the currency. If your forecast is in sterling, the risk-free rate is a gilt yield and the ERP is a UK premium. A sterling forecast discounted at a dollar-derived WACC has a currency mismatch buried inside it, and that is the kind of error that survives every check except someone reading the derivation.

For a defensible discount rate tied to the company being assessed, business valuation services can establish and document the relevant inputs.

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The private company problem

Here is what the textbooks skip. CAPM was built for listed companies. Yours has no share price, so it has no beta. It has no market capitalization, so it has no market-value weights. It may have no traded debt at all.

Three adjustments close the gap.

1. Borrow a beta and re-lever it

Take the observed betas of five to ten listed comparables. Strip out the effect of each one's capital structure to get an unlevered (asset) beta, take the median, then re-lever it at your target structure:

Relevered Beta = Unlevered Beta × (1 + (1 − Tax Rate) × D/E)

Use the median rather than the mean — comparable sets are small and one outlier distorts an average badly.

2. Add a size premium

Smaller companies have historically delivered higher returns than CAPM alone predicts, and investors price that in. The premium is typically 2–5% for companies below roughly £250M of enterprise value. Kroll publishes the standard dataset; Damodaran's is free.

3. Add a company-specific premium — carefully

This covers the risks that are yours alone: customer concentration, key-person dependency, a single supplier, a short operating history, no audited accounts. Typically another 1–4%.

This is the input most open to abuse in both directions. A seller's adviser sets it near zero; a buyer's adviser sets it near five. The defense is the same either way: name each risk, state the basis points you attached to it, and be willing to defend that allocation line by line. An unexplained lump is an invitation.

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A worked example

A UK software business, £10M free cash flow, planning to run at 25% debt and 75% equity once mature.

Every line is a number someone can question, and every line has an answer. That is the entire point. A WACC of 14.2% derived this way survives diligence. A WACC of 14% asserted in a single cell does not, even when it happens to be right.

The same business in dollars. Swap the gilt for the 10-year Treasury at 4.94%, the UK premium for the US one at 4.46%, and the 25% corporation tax rate for 21%, and the identical company comes out at 13.6%. The half-point gap is not a rounding difference — it is the currency of the cash flows, and it is why the risk-free rate has to match the forecast.

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WACC is not your hurdle rate

These get used interchangeably and they are not the same thing.

WACC is what your capital costs. It is an average across the whole business — every product, every market, every project you already run.

A hurdle rate is what you require from a specific decision. It should reflect the risk of that decision, not the average risk of the company.

Discounting a speculative new-market launch at the same rate as a maintenance capex project means you will systematically overvalue the risky one and underinvest in the safe one. In practice, most companies set a hurdle rate at WACC plus a margin — often 200 to 500 basis points — and add more for genuinely new risk.

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Five WACC mistakes worth checking for

1. Discounting levered cash flow at WACC. Double-counts the tax shield. WACC belongs with unlevered free cash flow.

2. Book weights instead of market weights. Book equity is an accounting residual. It has nothing to do with what the equity is worth.

3. A mean comparable beta instead of a median. With a set of six to ten, one outlier drags the average somewhere indefensible.

4. A currency mismatch. Sterling cash flows discounted at a dollar WACC.

5. A WACC hardcoded into a cell. If your discount rate is typed as 13% inside a formula rather than driven from an inputs tab, nobody can see the derivation — including you, six months later. This is the single most common defect we find in models that come in for review.

When the underlying workbook needs a transparent WACC schedule and sensitivity analysis, financial modeling services can build those calculations into the model.