How to calculate WACC in Excel
(Step-by-Step)

We live in a world of giant business setups and multinational companies that’d make billions and trillions in profits every year leaving us in awe.

But do you know? One of the key investment-driving-factors for these businesses is their WACC.

WACC is a crucial metric of corporate finance that profoundly influences every business’s investment decisions and capital structure optimization.

Businesses use WACC as their discount rate for cash flow valuations and it is the WACC of a business that decides if a project should be undertaken by it or not. How?

As we walk down through this article, you’ll learn all this and much more 👨‍🏫

This tutorial is all about the concept of WACC, how it works out, and most importantly how you calculate it in Excel. Here’s your practice workbook for this guide, download it and come along with me.

Table of Contents

What is WACC

WACC stands for the Weighted Average Cost of Capital.

The above term has two major parts to decipher; weighted average and the cost of capital.

Weighted average tells that we are going to average out some numbers based on their proportion.

And the cost of capital, in the simplest terms, means the cost you’re bearing for your capital 💰

The capital of an entity means the funds the entity has. Funds can come from two sources:

Equity (either that’s the owner’s money given against shares of the entity)

Debt (or you have sought lending from the bank or some other lenders)

Both the sources of funds have their own cost. The cost you pay on equity is the Cost of Equity (denoted by Ke), and the cost you pay on debt is called the Cost of Debt (Kd).

Averaging these costs out (based on their weight in the company’s capital structure) you get the WACC of an entity.

Formula of WACC

The formula for WACC is as follows:

A closer look into the formula reveals that we are multiplying

• the cost of equity to equity’s portion within the total capital; and
• the cost of debt to the debt’s portion of the total capital.

And then adding them up.

You can call that the basic formula. Taking it a step ahead, it has an additional component to it:

The only addition is of the Tax percentage deducted from the debt portion of this formula. Why is that? Explained in the section below.

Components of WACC

From the formula above, we know that WACC has the following components.

Equity

Equity represents the [start-highlight]capital injected[end-highlight] by the owners of the business into the business. For example, if you’re running a business with a capital model of $1000 million.

To the said amount of capital, you have contributed $400 million so, your equity portion will be:

The owners of the business are subject to share in the profits of the business (what we call dividends). Additionally, they enjoy the capital appreciation of the business. As the business grows and its net assets increase, the value for equity providers increases 📈

Debt

Debt as we all know is the money lent to us by external lenders. Most of the time, the lender would be a bank. Other times, it could be any party who wanted to invest in the business for a fixed return (interest) and return of investment after a certain period (loan repayment).

For example, if you’re running a business with a capital model of $1000 million, out of which $600 million is loaned, your debt portion would be:

Cost of Debt

The cost of debt is what you pay on your debts. Very simply, this will be a fixed rate of interest agreed with the lender. The payment of interest will be periodic depending on the agreement (can be annually, bi-annually, quarterly or even monthly)

For example, your bank agrees to loan you $600 million for your business at a fixed interest rate of 10% per annum. So, you get to pay 10% of $600 (that equals $60 million) every year.

Your Cost of Debt is 10% per annum.

Tax Rate

Delving down deeper into finance (and a little into taxes too), we know interest expense is tax deductible.

This means that tax authorities do accept interest expense as an expense and hence allow companies to deduct it from their taxable profit that’s subject to tax.

Pro Tip!

If a Company made annual sales of $ 3000 million, and the corporate tax rate applicable to the Company is 30%.

The Company would work out its taxable profit first. To do that, it will deduct its expenses from the revenue to reach the figure of profit. Tax laws normally allow companies to deduct the interest paid during the year as an expense too.

Hence, the Company doesn’t pay tax as $3000 million * 10% tax rate = $300 million. Instead, it pays $2940 million [$3000 million less $60 million interest paid] * 10% tax rate = $294 million in taxes.

Tax amounting to $6 million saved on account of interest expense.

While we paid the cost of debt of $60 million, we also saved $6 million (10% tax deduction on interest expense) in taxes. We paid $54 million on the net (that’s 9% of $600 million).

So, technically, our Cost of Debt is not 10% but 10% * [1 – 10%] = 9% after tax adjustment 💡

Cost of Equity

And then the cost of equity (denoted by Ke).

The cost of equity (that’s paid to owners) consists of two components i.e., the dividends paid to them and the appreciation they seek in the value of their shares over time.

It is determined using CAPM (Capital Asset Pricing Model).

Here’s the formula for it:

CAPM (Ke) = Rf + Rm – Rf (Be)

It is a formula that calculates Ke based on the

• market rate of return / risk premium (what other similar companies in the market are paying to their equity owners) > Rm
• the risk-free rate of return > Rf
• and the relative risk rate for each business / Beta Equity > Be

Pro tip

The cost of equity is not tax deductible. Tax authorities do not allow dividends as an expense, so we do not take any tax rate adjustment on the Cost of Equity.

Calculating WACC in Excel

Calculating WACC is no big deal with smart spreadsheet software like Excel.

I will put together an example below to show you how can you calculate WACC in Excel in under 2 minutes ⏱

Here’s the capital structure of a Company with some equity and debt. We also have the Cost of Equity, Cost of Debt, and tax rates given.

Step 1) Let’s bring the amount of capital parallel to its respective cost.

No tax rate adjustments apply to equity, so we have taken the tax rate to be applied to equity as 0%.

For cost of debt, remains 10% (as given in the data).

Step 2) Make the tax rate adjustments by deducting the tax rate from the cost of capital as follows:

Step 3) Repeating the same for the cost of debt, we get the post-tax cost of debt as 7.2%.

Step 4) Multiply the amount of equity with the % of the cost of equity by writing the following formula.

Step 5) Next, multiply the amount of debt with the post-tax % of the cost of debt by writing the following formula.

Nice.

Step 6) Now sum up the costs by using the SUM function as below.

Step 7) To find the WACC, divide the sum of the cost of capital by the capital as below.

There it comes as 8.93% ✌

This WACC percentage means we’re paying 8.93% per year for our capital, on average. Not a bad one, though.

Alternatively, if you want to find WACC through the formula discussed above, here’s it:

Step 1) Find the proportion of equity and debt as a part of the total capital by using the following formula.

That shows this capital structure runs on 36% equity and 64% debt.

Fast-forward to having calculated the post-tax cost of debt by using the same steps as in the above method.

Step 2) Multiply the proportion of equity and debt by their respective post-tax cost %, like here.

Step 3) Add up the percentages you’ve got.

There you go! We get a WACC of 8.93% again.

Both methods work equally fine (and are mathematically the same). You can use whichever you find easier ✔

With this, you now know how to calculate WACC in Excel.

How to interpret WACC

WACC is the most important financial metric for any business when it comes to investment related decision-making and evaluating new projects. In other words, it tells them how much expected return they should seek on their investments to make sure they’re not doomed.

It tells them the cost they are bearing based on which they determine the return they should be seeking to be in profit 🤔

For example, if your business has a WACC of 8.93%, you need to look out for projects that at least offer an 8.93% return or higher.

If you come across a project that offers, say a return of 6% per annum, you know by your WACC that you must not invest in it. That’s because that money you’ll invest into it comes for an 8.93% cost whereas you only make 6% out of that project.

Clearly in loss.

Pro Tip!

The lower the WACC, the better.

A smaller WACC percentage means you have sought cheap capital. This means you have more room to look out and invest in projects that come your way (even those with a lesser % of returns).

In the above example, you could have invested in the 6% return-yielding project if your WACC was 5% (making 1% profit). But a higher WACC (8.93%) means you cannot grab many investment opportunities around you 🎯

Conclusion

Here we come to an end to this tutorial that comprehensively covers everything about calculating WACC in Excel.

From the concept of what runs behind it to calculating it through different methods. Wooho! You’re a finance wizard by now 🎓

However, the concept of WACC remains incomplete unless you use it for calculating NPV for your project cash flow. NPV is a financial modeling technique that uses the DCF model to calculate the discounted cashflows of a project based on it’s WACC.

Read my blog on how to calculate NPV in Excel here.

Additionally, I also suggest you read my blog on calculating IRR in Excel. All these concepts are intertwined, and the more you study them, the more know how financial operations in Excel work.