Financial Management · Estimating the cost of capital

How to Calculate WACC in ACCA Financial Management

Updated 11 October 2026 · Fact-checked

WACC is the average cost of a company's long-term finance, weighted by the market value of each source. Find the cost of each source (after tax for debt), multiply by its share of total market value, and add. Use it as the discount rate for projects with similar business risk and financing.

Understand Weighted Average Cost of Capital (WACC)

A company raises money from different sources: ordinary shares, preference shares, bonds and loans. Each source has a different cost because investors need different returns for different risk. The weighted average cost of capital (WACC) combines these into one rate.

The weights matter. Use market values, not book values. Market values show what investors would require today, and they are the amounts the company would have to raise or repay at current prices. Book values are historical and can be far from reality. Equity is usually the biggest difference, because the market value of shares is often well above the balance sheet figure.

Debt is cheaper than equity for two reasons. Lenders carry less risk, and interest is tax deductible. So you use the after-tax cost of debt. Equity and preference dividends are not tax deductible, so no tax adjustment is made.

WACC is used as the discount rate in NPV. This only works if certain assumptions hold: the project has the same business risk as the company's existing operations, the company keeps its current capital structure (gearing) in the long term, the new finance is a marginal change in size, and the cost of capital stays constant. If a project is of a different risk, or changes gearing a lot, WACC is the wrong rate. You would then use a project-specific rate, for example an adjusted beta in CAPM.

Convertible debt and preference shares are classic exam twists. Preference shares are treated like irredeemable debt without tax relief. Convertible bonds are valued at what the holder will actually get: the higher of redemption value and conversion value.

Key rules to remember

WACC: WACC = [E × ke + P × kp + D × kd(1 − T)] ÷ (E + P + D); E, P and D are the market values of equity, preference shares and debt. T is the tax rate. For debt that is redeemable or convertible, use the IRR-based after-tax cost instead.
Cost of equity (CAPM): ke = Rf + β × (Rm − Rf); Rf is the risk-free return, Rm the market return. (Rm − Rf) is the equity risk premium.
Cost of equity (dividend growth model): ke = [D0 × (1 + g) ÷ P0] + g; P0 must be the ex-dividend price. D0 is the dividend just paid.
Irredeemable debt after tax: kd = Interest × (1 − T) ÷ Market value; Use the market value of the debt per $100 nominal and the interest on the same $100.
Preference shares: kp = Preference dividend ÷ Market price; No tax adjustment. Treat as irredeemable unless told otherwise.
Redeemable debt: kd = IRR of: −Market price now, + after-tax interest each year, + redemption value at the end; Use two trial rates and interpolate. Tax relief on interest is included in the cash flows.
Convertible debt: kd = IRR using the higher of redemption value and conversion value at the conversion date; Conversion value = expected future share price × conversion ratio. Compare it with the redemption value.
Market value weights: Weight = Market value of source ÷ Total market value of all sources; Shares: number of shares × share price. Debt: nominal × market price ÷ 100.

How to solve Weighted Average Cost of Capital (WACC) questions

Use this order for any WACC question. It keeps the working tidy and shows the marker each mark-earning step.

1List every source of long-term finance in the question: ordinary shares, preference shares, bonds, bank loans. Ignore short-term finance unless told to include it.
2Find the market value of each source. Shares: number × price (ex-div). Debt: nominal × price ÷ 100. Use book value only if no market value is given, and say so.
3Calculate the cost of equity with CAPM or the dividend growth model, as the data allows. Use the ex-dividend price.
4Calculate the after-tax cost of each debt type. Irredeemable: interest × (1 − T) ÷ price. Redeemable or convertible: IRR on after-tax cash flows.
5Calculate the cost of preference shares: dividend ÷ market price, with no tax adjustment.
6Multiply each cost by its market value, add the results and divide by total market value. Show the weights or the totals clearly.
7State the WACC to a sensible precision, usually one or two decimals.
8If asked, use WACC as the NPV discount rate and state the assumptions: same business risk, constant gearing, marginal project, constant costs.

Quickest way: Value-times-cost table

When to use it: Use it in Section C or in an OT case where you have several sources and little time.

Draw a three-column table: market value, cost, value × cost.
Fill in market values first, in $m or $000.
Compute each cost and write it as a percentage.
Multiply value × cost for each row. Sum the column and the market values.
Divide the total of value × cost by the total market value. You never need to calculate separate weights.
Sense-check: WACC must fall between the cheapest and dearest cost, and lean towards the biggest source.

Common mistakes in Weighted Average Cost of Capital (WACC)

Using book values for weights when market values are given
Balance sheet numbers look familiar and the share price is hidden in the question text.
Fix: Always search the question for share prices and bond prices first. Shares are number × price, not share capital plus reserves.
Forgetting to adjust debt for tax
Students remember the cost formula but skip the (1 − T) step under time pressure.
Fix: Write kd(1 − T) in your table heading. Only debt interest gets tax relief, not preference or equity dividends.
Using the cum-dividend share price in the dividend growth model
The price is given without noticing the dividend is about to be paid.
Fix: Check whether the price is ex-div or cum-div. If cum-div, subtract the imminent dividend before you use the model.
Treating convertible bonds as ordinary redeemable debt
The conversion option is ignored, or students assume redemption at par.
Fix: Work out the conversion value (future price × shares per bond) and compare it with redemption value. Use the higher in the IRR calculation.
Applying the market value of debt as nominal value
Debt is quoted at $100 nominal, and the quoted price is a percentage of that.
Fix: Market value = nominal × price ÷ 100. A bond quoted at 96 is worth $96 per $100 nominal.
Using WACC for every project without checking risk
WACC is taught as the standard discount rate, so the conditions are forgotten.
Fix: In discussion questions, state that WACC is valid only if the project's business risk and the financing mix match the existing company. Otherwise use a project-specific rate.

Worked examples

Example 1

Delta plc has 10 million ordinary shares with a market price of $3.00 each. Its equity beta is 1.2, the risk-free rate is 4% and the market return is 10%. It also has $12 million nominal of 6% irredeemable bonds, quoted at $90 per $100 nominal. The tax rate is 25%. Calculate the WACC using market values.

Show the solution

Market value of equity = 10m × $3.00 = $30m.
Market value of debt = $12m × 90 ÷ 100 = $10.8m. Total market value = $40.8m.
Cost of equity (CAPM) = 4% + 1.2 × (10% − 4%) = 4% + 7.2% = 11.2%.
After-tax cost of debt = 6 × (1 − 0.25) ÷ 90 = 4.5 ÷ 90 = 5.0%.
WACC = (30 × 11.2% + 10.8 × 5.0%) ÷ 40.8 = (336 + 54) ÷ 40.8 = 390 ÷ 40.8 = 9.56%.

Answer: WACC ≈ 9.56%.

Example 2

Echo Ltd has equity with a market value of $20 million and a cost of equity of 12%. It has 5 million 8% preference shares of $1 nominal, trading at $0.80 each. It has $10 million nominal of 7% bonds, priced at $96 per $100 nominal, redeemable at par in 3 years. The tax rate is 20%. Calculate the WACC.

Show the solution

Preference shares: market value = 5m × $0.80 = $4m. Cost = 0.08 ÷ 0.80 = 10%.
Debt market value = $10m × 96 ÷ 100 = $9.6m. Total market value = 20 + 4 + 9.6 = $33.6m.
After-tax interest per $100 = 7 × (1 − 0.20) = $5.60. Cash flows: −96 now, +5.60 in years 1 and 2, +105.60 in year 3.
At 7%: 5.60 × 2.624 + 100 × 0.816 = 14.69 + 81.63 = 96.32 (annuity factor 2.624 for years 1 to 3; redemption discounted at 1.07³).
At 8%: 5.60 × 2.577 + 100 × 0.794 = 14.43 + 79.38 = 93.81.
IRR = 7% + [(96.32 − 96.00) ÷ (96.32 − 93.81)] × 1% = 7% + 0.13% = 7.13%.
WACC = (20 × 12% + 4 × 10% + 9.6 × 7.13%) ÷ 33.6 = (240 + 40 + 68.45) ÷ 33.6 = 348.45 ÷ 33.6 = 10.37%.

Answer: WACC ≈ 10.37% (about 10.4%).

Exam tips

Write the market values first. Many marks go for correct weights, and you can pick up method marks even if a cost is wrong.
Read the question for ex-div and cum-div wording, tax rates and the redemption date before you start.
In Section A and OT cases, answers are all or nothing. Do the calculation on scrap paper in the table layout and check the units ($m or $000) before choosing an option.
For discussion parts, link each WACC assumption to the project: same business risk, unchanged gearing, marginal investment and constant costs. Then say what you would do if one fails.
For convertible bonds, always show both the redemption value and the conversion value, and say which one is higher.

Practice questions from Estimating the cost of capital

Weighted Average Cost of Capital (WACC) in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Weighted Average Cost of Capital (WACC): frequently asked questions

Why use market value instead of book value in WACC?

Market values show what investors require now and what it would cost to raise the finance today. Book values are historical and can be very different, especially for equity. Use book values only if market values are not given.

Do I adjust preference shares for tax?

No. Preference dividends are paid out of after-tax profit and do not give tax relief. Cost = dividend ÷ market price. Only debt interest is adjusted by (1 − T).

What are the main assumptions and limitations of WACC?

WACC assumes the project has the same business risk as the company, that gearing stays at the current level, that the project is small relative to the company and that costs of capital are constant. It is hard to measure the true cost of equity and market values change daily. If the assumptions fail, use a project-specific discount rate.

How do I treat convertible debt in a WACC question?

Find the future conversion value (expected share price × shares per bond) and compare it with the redemption value. Assume the holder takes the higher. Then calculate the IRR of the after-tax cash flows and use that as the cost of the convertible.