WACC · AOSM
Weighted Average Cost of Capital
Short definition
WACC is the weighted cost of equity and debt at the target capital structure. FCFF is discounted at this rate; interest is not deducted again in FCFF.
Detailed explanation
Ke is CAPM or a built-up equity cost, Kd is all-in debt cost, T is the marginal rate at which the shield is actually used. Weights are the target structure (market values); book leverage misstates WACC.
Country risk sits once in Ke or Kd; stacking CRP, spread and an extra “project premium” can count the same risk three times. Use nominal WACC with nominal cash, real WACC with real cash.
Why it matters for the CFO
It is the hurdle for investment, M&A and valuation. Inflating WACC by 1 point often cuts EV materially. In some Turkish periods Kd approaches or exceeds Ke; the “debt is always cheaper” assumption breaks.
How it is calculated
WACC = E/(D+E)×Ke + D/(D+E)×Kd×(1−T)
E and D are target market weights. (1−T) applies the shield to Kd; FCFF already excludes interest. If the shield cannot be used (persistent losses), (1−T) tends toward 1.
Variables in the formula
- E: Equity market value (target weight in a target structure)
- D: Net financial debt (target weight)
- Ke: Cost of equity
- Kd: Pre-tax cost of debt
- T: Marginal corporate tax (if the shield is usable)
How to read it
WACC sits between Ke and after-tax Kd. More leverage first cuts WACC, then distress and a higher Ke can lift it. If the target structure differs from today’s, do not use today’s weights. There is no universal “right WACC”; beta, country risk and debt cost set it.
Numerical example
E weight 60%, Ke 22%, D weight 40%, Kd 18%, T 25% → WACC = 0.60×22% + 0.40×18%×0.75 = 13.2% + 5.4% = 18.6%.
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Definitions are educational. They are not investment, credit or tax advice.