WACC

WACC blends the return shareholders expect with the after-tax interest the company pays. It is the minimum return the business must earn on its capital to satisfy everyone who funds it.

The inputs

• Weights: the market value of equity (market cap) and of debt (book value of borrowings is the usual stand-in).
• Cost of equity: usually estimated with CAPM, the risk-free rate (the 10-year Government of India bond yield) plus beta times the equity risk premium.
• Cost of debt: the rate the company would pay on new borrowing, reduced by the tax saving, because interest is tax-deductible.

How it is used

In a DCF, WACC is the discount rate for free cash flow to the firm, and the value is very sensitive to it: a one-point change can move a valuation by 10% to 25%. In performance analysis it is the hurdle: a company creates value only when its return on invested capital is above its WACC. The WACC formula page works through a full example with every input.

Where the inputs come from

Market cap from the exchange; borrowings from the balance sheet; the interest rate from the finance costs note, divided by average borrowings; the tax rate from the tax note; beta from a regression of the stock's returns against the index, or an average of listed peers.

Common mistakes

• Using the book value of equity for the weights. Investors care about what the equity is worth today.
• Treating WACC as precise. Each input is an estimate, so work with a range.
• Assuming more debt keeps lowering WACC. More debt makes the equity riskier and raises the cost of both.
• Using WACC for banks. Deposits are a lender's raw material, not financing, so banks are discounted at the cost of equity.

Questions investors ask

Why is debt cheaper than equity? Lenders are paid before shareholders and interest is tax-deductible, so lenders accept a lower return.

What is a typical WACC for an Indian company? There is no single figure. It depends on the company's risk and capital structure and on interest rates at the time, so work it out from current inputs and test a range.

Does WACC change over time? Yes. It moves with interest rates, with the share price, which changes the weights, and with the company's borrowing, so recalculate it whenever any of these shift.