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Corporate finance

WACC and financing costs

Combine equity and after-tax debt costs using market-value weights, then check whether matches the risk of cash flows being discounted.

Explore financing weights and the tax shield

01 · Make a predictionHolding other assumptions fixed, how does a higher tax rate affect WACC?

Equity cost 10%; pre-tax debt cost 5%; debt weight = 100% − equity weight.

WACC7.60%
After-tax debt cost4.00%

After-tax debt cost

0.05×(1−0.2)≈0.04

Weight by equity/debt market values, then convert to %

WACC=(0.6×0.1+0.4×0.04)×100%≈7.60%

What did you just see?

Cheaper after-tax debt can reduce the average, but leverage can also raise both equity and debt required returns; costs need not stay fixed.

Match the cash flows

This tool models one equity source and one debt source. Preferred stock or other financing sources need their own weights and costs; the result is not a complete valuation.

Inspect the capital structure

Scaling both market values equally leaves unchanged. All-equity or all-debt inputs are allowed; unused financing costs remain assumptions rather than contributions.

Another example

  1. Enter equity market value 600 and debt market value 400 in the same currency.
  2. After-tax debt cost is 5% × (1−20%) = 4%.
  3. Add equity contribution 6% and debt contribution 1.6% to get 7.6%.
Show formal definition and formula

Weighted average cost of capital combines equity and debt required returns using financing weights.

E
Equity market value, in the same amount unit as debt.
D
Debt market value; E + D must be positive.
Re
Cost of equity.
Rd
Pre-tax cost of debt.
T
Marginal tax rate, 0–100%; assumes deductible interest.

Common mistakes

Do not mix historical book weights, different currency rates, or unmatched cash-flow risk, and do not treat the tax shield as guaranteed cash income.

Frequently asked questions

Should I use market or book values?

Market or target market-value weights are usual. Book values reflect accounting history; use them as a documented proxy only when market values are unavailable and the approximation is reasonable.

Can WACC be used for DCF?

Use it to discount FCFF with matching risk, currency, and horizon. Equity cash flows usually use cost of equity, and projects with different risks need an appropriate rate.

You can now explore…

  • Separate market-value weights and weighted contributions
  • Understand tax shields and DCF discount-rate limits
Term reference2 terms

Open a term when you need a reminder. Underlined words in the article work too.