About the Cost of Capital (WACC)
The weighted average cost of capital is what your money costs on average — the cost of equity weighted by the equity share plus the after-tax cost of debt weighted by the debt share. It is the hurdle rate a project must beat: a project earning less than the WACC destroys value even if it is profitable on paper.
Enter the amounts of equity and debt, the return your owners expect on equity, the interest rate on debt and the tax rate. Interest is tax-deductible, so the after-tax cost of debt is the rate times (1 − tax rate). The result is the blended rate to use as the discount rate in the IRR & NPV calculator.
For a small business the cost of equity is a judgement — the return the owners need for the risk they take, typically well above the bank rate. A conservative figure keeps project appraisals honest.
How to use it
- 1Enter the equity and the debt in the capital structure.
- 2Enter the cost of equity (the owners' expected return) and the interest rate on debt.
- 3Enter the income-tax rate.
- 4Read the WACC and use it as the discount rate for projects.
How this is calculated
WACC = (E ÷ (E + D)) × cost of equity + (D ÷ (E + D)) × cost of debt × (1 − tax rate)
Frequently asked questions
What cost of equity should a small business use?
The return the owners need to justify the risk — usually more than a fixed deposit or a listed-equity index return. Many MSME appraisals use 15–20 %. It is an assumption; state it in any report that uses the WACC.
Why is the cost of debt reduced by tax?
Interest is deducted before tax is computed, so every rupee of interest saves tax at your marginal rate. The effective cost of borrowing is therefore lower than the coupon rate.
Should I use book or market values?
Market values are theoretically right; for an unlisted business book values are the practical choice. Use the current balance sheet.
How is WACC used?
As the discount rate for NPV and as the minimum acceptable IRR. A project with an IRR above the WACC adds value; below it, it does not — regardless of accounting profit.