WACC Calculation: Formula, Worked Example and Pitfalls

What WACC is for, and why its calculation matters

WACC (weighted average cost of capital) is the minimum return a company must earn to satisfy those who finance it: its shareholders and its lenders. It is the discount rate in a DCF, the method that values a business by its future cash flows brought back to today.

The WACC calculation weighs heavily on the result. The higher the rate, the less distant cash flows are worth today, and the lower the value. We quantify it below: one point of WACC moves the value by about 10%.

The WACC formula

The formula fits on one line:

WACC = E/(E+D) × Ke + D/(E+D) × Kd × (1 − t)

Symbol	Meaning
E	Value of equity (what belongs to the shareholders)
D	Financial debt
Ke	Cost of equity: the return shareholders expect
Kd	Cost of debt: the interest rate paid to lenders
t	Corporate tax rate

The (1 − t) term exists because interest is deductible from taxable profit: debt costs less after tax than before. WACC is therefore an average of the two costs, weighted by the share of each source of financing.

Step 1: the cost of equity (Ke)

Shareholders have no contractual interest rate, so it is estimated with the CAPM (capital asset pricing model), supplemented for an SME:

Ke = risk-free rate + beta × market risk premium + size and illiquidity premium

• The risk-free rate is the yield on long-term government debt, for example the 10-year government bond.
• The market risk premium is the extra return investors demand for holding shares rather than government bonds.
• Beta measures how sensitive the sector's shares are to market movements. A beta of 1.2 means the sector amplifies market moves by 20%.
• The size and illiquidity premium compensates for the fact that an unlisted SME is more fragile than a large group and that its shares are hard to sell.

The beta of an unlisted SME cannot be observed. You start from the beta of comparable listed companies, which you "unlever" to neutralise the effect of their debt, then "relever" with the target capital structure of the company being valued:

levered beta = unlevered beta × (1 + (1 − t) × D/E)

Step 2: the cost of debt (Kd)

The cost of debt is simpler: it is the rate at which the company would borrow today. Use the rate on its recent loans or a bank quote, not the historical rate of a loan signed ten years ago. After tax, multiply it by (1 − t).

Step 3: the target capital structure

The weights E/(E+D) and D/(E+D) are not those of today's balance sheet. Use the target structure, the one a normal company in the sector adopts over time, with the market value of equity rather than its book value. This stops a company that is temporarily heavily indebted, or has no debt at all, from distorting its own rate.

Worked example: Ateliers Durand

Let us return to our fictional SME, Ateliers Durand (€8.2m turnover, €1.1m EBITDA, €0.6m net debt). The parameters below are illustrative assumptions, not market measurements.

Starting assumptions:

Parameter	Value
Risk-free rate	3.3%
Market risk premium	5.5%
Sector unlevered beta	1.0
Target structure	80% equity, 20% debt (D/E = 25%)
Size and illiquidity premium	2.6%
Pre-tax cost of debt	5.5%
Tax rate	25%

Step-by-step calculation:

Step	Calculation	Result
Levered beta	1.0 × (1 + 0.75 × 0.25) = 1.1875, rounded	1.2
Cost of equity	3.3% + 1.2 × 5.5% + 2.6%	12.5%
After-tax cost of debt	5.5% × (1 − 0.25)	4.125%
WACC	80% × 12.5% + 20% × 4.125% = 10.0% + 0.825%	10.8%

This is the 10.8% rate we use for Ateliers Durand in our article on the four methods for valuing an SME.

What one point of WACC does to value

Let us measure the effect on a simple case: a company that generates €0.8m of cash flow a year from next year, growing at 2% a year in perpetuity. Its value is cash flow ÷ (WACC − growth).

WACC	Calculation	Value of the cash flows
9.8%	0.8 ÷ (9.8% − 2%)	€10.3m
10.8%	0.8 ÷ (10.8% − 2%)	€9.1m
11.8%	0.8 ÷ (11.8% − 2%)	€8.2m

One point less of WACC adds about 13% to the value, one point more takes off about 10%. This is why a DCF is always presented as a range, with several rates tested, rather than a single figure.

Common pitfalls in a WACC calculation

1. Taking the capital structure from today's balance sheet. A company in the middle of deleveraging would give a WACC that is too high. Use the sector's target structure.
2. Forgetting to relever the beta. The beta read from listed companies reflects their own debt. Without the recalculation, you mix two capital structures.
3. Neglecting the size premium. Applying a large group's cost of equity to an SME overstates its value. Conversely, stacking premiums without justification makes it collapse.
4. Using a historical debt rate. Only the rate at which the company would borrow today matters.
5. Forgetting the tax shield on debt. Without the (1 − t) factor, WACC is overstated.
6. Mixing currencies or horizons. The risk-free rate must be in the currency of the cash flows and of a comparable maturity.
7. Believing in precision. WACC rests on estimates: two serious analysts will arrive at rates that differ by a point. Read it as a range of 1 to 2 points, not an exact value.

How to check your WACC calculation

Once the WACC is calculated, two quick checks catch input errors:

• WACC must sit between the after-tax cost of debt and the cost of equity. Here, between 4.1% and 12.5%.
• It must remain consistent with the sector. For an industrial or services SME, it often falls between 8% and 12%. A result far outside that range deserves a second look.

Bridgesheet's WACC calculator follows these steps and lets you change every assumption. It is free. To use it in a full valuation, the DCF model takes the rate and runs the cash flows year by year.