Financial Management · Sources of finance and their relative costs

Weighted Average Cost of Capital (WACC) for 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. You find the cost of each source (equity, debt, preference shares), multiply by its market-value proportion, and add the results. Debt cost uses after-tax interest.

Understand Weighted Average Cost of Capital (WACC)

A company raises money from different sources. Shareholders expect a return. Lenders charge interest. Each source has a different cost. To judge a project you need one rate that reflects the whole mix. That rate is the weighted average cost of capital (WACC).

The weights matter. Use market values, not book values. Market value shows what investors would pay today, so it reflects what each group currently requires and the real claim each group has on the business. Book values are historical and often far from market value, especially for equity.

Cost of equity comes from the dividend valuation model or CAPM. Cost of debt is the after-tax cost: interest saves tax, so you reduce it by the tax rate. For redeemable debt you find the after-tax IRR of the cash flows, using market price, interest after tax and redemption value.

WACC is used as the discount rate in NPV. It is only suitable when the project has the same business risk as the existing business and when the company's capital structure stays about the same, so financing does not change the overall risk. If either condition fails, WACC is not the right rate. A project in a different line of business needs a rate based on that risk, and a big change in gearing changes the cost of equity.

Expect to calculate each cost, build market-value weights, and then comment on the result.

Key rules to remember

WACC: WACC = [E ÷ (E + D + P)] × Ke + [D ÷ (E + D + P)] × Kd(1 − T) + [P ÷ (E + D + P)] × Kp; E, D, P are market values of equity, debt and preference shares. Drop P if there are none.
Cost of equity (dividend growth model): Ke = [D0 × (1 + g) ÷ P0] + g; D0 is the dividend just paid. P0 is the ex-dividend share price.
Cost of equity (CAPM): Ke = Rf + β × (Rm − Rf); Rm − Rf is the equity risk premium. Use the data given.
After-tax cost of irredeemable debt: Kd = [i × (1 − T)] ÷ P0; i is annual interest, P0 is the ex-interest market price of the debt.
Cost of redeemable debt: Kd = the IRR of: − market price now, + interest × (1 − T) each year, + redemption value at the end; Use two discount rates and interpolate.
Cost of preference shares: Kp = preference dividend ÷ market price; No tax adjustment, as dividends are not tax deductible.
Market value of equity: E = number of shares × share price; Use ex-dividend prices.

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

Follow the same order each time. It keeps the working tidy and lets markers follow your method.

1List each source of long-term finance and its market value. Equity = shares × price. Debt = nominal value × quoted price ÷ 100.
2Calculate the cost of equity using the dividend growth model or CAPM, whichever the data supports.
3Calculate the after-tax cost of debt. Use the simple formula for irredeemable debt and an IRR for redeemable debt.
4Calculate the cost of preference shares if any, with no tax adjustment.
5Work out total market value and each source's weight.
6Multiply each cost by its weight and add to get WACC.
7If asked, comment on the use of WACC: same business risk, stable gearing, and the assumption that market values reflect the future.

Quickest way: Table method with total market value

When to use it: Use it in Section B or C when you have several sources of finance and limited time.

Draw three columns: market value, cost, value × cost.
Fill in each market value in the first column and add them up.
Put the after-tax cost beside each.
Multiply market value by cost in the third column and total it.
Divide the third column total by the total market value. This avoids calculating each weight separately.

Common mistakes in Weighted Average Cost of Capital (WACC)

Using book values as weights
The statement of financial position is the easiest figure to find.
Fix: Use market values whenever they are given. Use book values only if the question says no market values are available.
Not adjusting debt for tax
Students remember interest rates but forget tax relief.
Fix: Multiply interest by (1 − T) for debt. Never do this for preference shares or equity.
Using cum-dividend share price in the growth model
The price in the question is taken without checking.
Fix: If a dividend is just due, subtract it from the price to get the ex-dividend price before using it.
Valuing debt at nominal value rather than market price
Quoted prices are per ₹100 or $100 nominal, and are overlooked.
Fix: Market value = nominal × quoted price ÷ 100. Check the quote basis.
Applying WACC to every project
Students treat WACC as a universal rate.
Fix: Say that WACC applies only when the project has the same business risk and the financing mix is unchanged.
Forgetting to multiply D0 by (1 + g)
The formula is memorised incompletely.
Fix: Write D1 = D0 × (1 + g) as its own line before dividing by price.

Worked examples

Example 1

Company X has 4 million equity shares at $2.50 ex-div. The last dividend was 20 cents and dividends grow at 5% a year. It also has $3 million nominal of 6% irredeemable bonds trading at $80 per $100 nominal. Tax is 25%. Calculate WACC.

Show the solution

Market value of equity = 4,000,000 × 2.50 = $10,000,000.
Market value of debt = 3,000,000 × 80 ÷ 100 = $2,400,000.
Ke = [0.20 × 1.05 ÷ 2.50] + 0.05 = 0.084 + 0.05 = 13.4%.
Annual interest = 6% × 3,000,000 = $180,000. After tax = 180,000 × 0.75 = $135,000.
Kd = 135,000 ÷ 2,400,000 = 5.625%.
Total market value = 10,000,000 + 2,400,000 = $12,400,000.
Equity weight = 10,000 ÷ 12,400 = 0.80645. Debt weight = 2,400 ÷ 12,400 = 0.19355.
WACC = 0.80645 × 13.4% + 0.19355 × 5.625% = 10.806% + 1.089% = 11.895%.

Answer: WACC is about 11.9%.

Example 2

A company has equity market value ₹60,00,000 with cost 12%, preference shares market value ₹10,00,000 paying 8% on a market price giving a cost of 10%, and bank debt market value ₹30,00,000 with a pre-tax cost of 8%. Tax is 30%. Calculate WACC and state one limitation of using it to appraise a new project.

Show the solution

After-tax cost of debt = 8% × (1 − 0.30) = 5.6%.
Total market value = 60,00,000 + 10,00,000 + 30,00,000 = ₹1,00,00,000.
Equity: 60,00,000 × 12% = ₹7,20,000.
Preference: 10,00,000 × 10% = ₹1,00,000.
Debt: 30,00,000 × 5.6% = ₹1,68,000.
Total = 7,20,000 + 1,00,000 + 1,68,000 = ₹9,88,000.
WACC = 9,88,000 ÷ 1,00,00,000 = 9.88%.
Limitation: it is only valid if the project has the same business risk as existing operations and the financing mix does not change.

Answer: WACC = 9.88%. It is unsuitable for projects with different business risk or that change gearing.

Exam tips

Read whether the share price is cum-div or ex-div before you start the cost of equity.
Always show a neat table of market values, costs and weights. Method marks are available even if one cost is wrong.
In Section A, watch for weights given as book values and market values together. The question usually wants market values.
When asked to discuss WACC, give two or three precise points: same risk, constant gearing, market values are current, and cost estimates are only approximations.
Round only at the end. Small rounding differences are usually accepted, but early rounding can push the answer outside the accepted range.

Practice questions from Sources of finance and their relative costs

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 values rather than book values in WACC?

Market values show what investors currently require and the actual size of each claim on the business. Book values are historical and can be far from current worth, especially for equity. Book values are used only if market values are not available.

Is the cost of debt before or after tax in WACC?

After tax. Interest is normally tax deductible, so the real cost to the company is lower. You multiply the interest by (1 − tax rate), or use after-tax cash flows in an IRR for redeemable debt.

Can I always use WACC as the NPV discount rate?

No. It is suitable when the project has the same business risk as the existing business and the company's gearing does not change significantly. Otherwise a risk-adjusted rate is needed.

Do preference shares get a tax adjustment?

No. Preference dividends are paid out of after-tax profit and are not deductible, so the cost is simply dividend divided by market price.