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Financial Management and Strategic Management · Cost of Capital

Weighted Average Cost of Capital (WACC) for CA Inter

Updated 4 October 2026 · Fact-checked

WACC is the average cost of a firm's long-term funds, with each source weighted by its share in total capital. Find each source's after-tax cost, find its weight using book or market values, multiply, add, and divide by total weights. Market value weights are theoretically better; use book weights when the question says so.

Understand Weighted Average Cost of Capital (WACC)

A company raises money from several sources: equity, retained earnings, preference shares and debt. Each source has a different cost. Debt is usually the cheapest because interest is tax deductible and lenders face less risk. Equity is the costliest because shareholders bear the most risk.

You cannot judge a project against just one of these costs. So you blend them into one figure. That figure is the Weighted Average Cost of Capital (WACC), also called the composite cost of capital. It is the minimum return a project should earn to keep the firm's value from falling.

The word 'weighted' matters. A source that forms 60% of capital should affect the answer more than one that forms 10%. The weight of each source is its value divided by total capital.

There are two ways to measure value. Book value weights use the figures in the balance sheet. They are simple and stable, but they ignore what investors would pay today. Market value weights use current market prices of shares and debentures. They reflect present reality, so they are generally preferred in theory. They need market prices, and these keep changing.

WACC is different from the marginal cost of capital. WACC is the average cost of the existing or planned capital mix. Marginal cost of capital is the cost of raising the next rupee of new funds. Read the question carefully to see which one is asked.

Key rules to remember

WACC
WACC = Σ(W × K) ÷ ΣW = (E×Ke + R×Kr + P×Kp + D×Kd) ÷ (E + R + P + D)
E, R, P, D are the amounts of equity, retained earnings, preference and debt. Use the same basis (book or market) for all of them. If weights are proportions that add to 1, no division is needed.
Weight of a source
Weight = Value of the source ÷ Total value of all sources
Value is book or market depending on the basis chosen.
After-tax cost of debt (irredeemable)
Kd = [I × (1 − t)] ÷ NP
I is annual interest, t is the tax rate, NP is net proceeds. For debt issued at par with no cost, NP equals face value. For redeemable debt, use the approximation or IRR method your question needs.
Cost of preference shares (irredeemable)
Kp = Preference dividend ÷ Net proceeds
No tax adjustment, because preference dividend is not tax deductible.
Cost of equity (dividend growth model)
Ke = D1 ÷ P0 + g
D1 is the expected dividend next year. D1 = D0 × (1 + g).
Cost of equity (CAPM)
Ke = Rf + β × (Rm − Rf)
Rf is the risk-free rate, Rm the market return, β the beta of the share.
Cost of retained earnings
Kr = Ke (when no floatation cost or personal tax adjustment is given)
Use the cost of equity unless the question gives an adjustment.

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

Use this order for every WACC question. It also gets you step marks even if one input is wrong.

  1. 1Read what is asked: WACC on book weights, on market weights, or both. Note whether it is existing capital or a proposed mix.
  2. 2List each source with its amount. If the question gives market prices, compute market value as number of shares × price, or debentures × price.
  3. 3Compute the cost of each source. Use the question's cost if given. Otherwise apply the right formula. Reduce debt cost for tax.
  4. 4Decide where retained earnings go. For book weights, show them separately or add them to equity at the same cost. For market weights, the market value of equity already includes them.
  5. 5Calculate weights, or work with amounts directly. Check the total is the sum of all sources.
  6. 6Multiply each amount or weight by its cost. Show a table: source, amount, weight, cost, weighted cost.
  7. 7Add the weighted costs and, if you used amounts, divide by total capital. Give the answer as a percentage to two decimals.
  8. 8Add one line of interpretation, for example why market-weight WACC is higher or lower than the book-weight figure.

Quickest way: Amount-times-cost table, divide once

When to use it: Use this in written answers and MCQs when amounts are given. It avoids computing several weight decimals and cuts rounding errors.

  1. Write amount and cost for each source in two columns.
  2. Multiply amount by cost in whole numbers, for example ₹ lakh × percentage.
  3. Add the products once and divide by total capital once.
  4. MCQ check: WACC must lie between the lowest and highest component cost. Eliminate options outside that range.
  5. MCQ check: if market value of equity is higher than book value and equity is the costliest source, market-weight WACC will be higher than book-weight WACC.
  6. Written format: show the table with headings, the formula line, then the final percentage. Step marks are given for each correct cost and weight.

Common mistakes in Weighted Average Cost of Capital (WACC)

  • Using pre-tax cost of debt in WACC

    The interest rate is given in the question and you plug it in directly.

    Fix: Always multiply by (1 − t) for debt unless the question says the cost given is already after tax.

  • Mixing book and market values in the same calculation

    Equity is taken at market price while debt and preference are left at book figures.

    Fix: Use one basis for all sources unless the question gives market values for specific items. Say which basis you used.

  • Counting retained earnings twice under market weights

    Market value of equity already reflects reserves, but students add reserves again.

    Fix: Under market weights, use number of shares × market price for the whole equity. Add retained earnings separately only under book weights.

  • Adjusting preference dividend for tax

    Students treat it like interest.

    Fix: Preference dividend is paid out of profit after tax. Do not apply (1 − t).

  • Confusing WACC with marginal cost of capital

    Both use weights and costs, so they look alike.

    Fix: WACC averages the existing or target capital mix. Marginal cost applies to the new funds being raised, at their own costs and weights.

  • Taking weights that do not add to 100%

    A source is left out or an amount is mis-added.

    Fix: Add the amounts first, then check that the weights sum to 1 before multiplying.

Worked examples

Example 1

A company has the following book capital: equity share capital ₹40,00,000 (4,00,000 shares of ₹10 each), retained earnings ₹20,00,000, 12% preference shares ₹10,00,000 and 10% debentures ₹30,00,000. The shares have a market price of ₹30 each. Preference shares and debentures are issued and trade at par. Cost of equity and retained earnings is 16%. The tax rate is 30%. Calculate WACC using (a) book value weights and (b) market value weights.

Show the solution
  1. Cost of each source: Ke = 16%, Kr = 16%, Kp = 12%, Kd = 10% × (1 − 0.30) = 7%.
  2. (a) Book values in ₹ lakh: equity 40, retained earnings 20, preference 10, debt 30. Total = 100.
  3. Weighted amounts: equity 40 × 16 = 640. Retained earnings 20 × 16 = 320. Preference 10 × 12 = 120. Debt 30 × 7 = 210.
  4. Sum = 640 + 320 + 120 + 210 = 1,290. WACC = 1,290 ÷ 100 = 12.90%.
  5. (b) Market value of equity = 4,00,000 × ₹30 = ₹1,20,00,000 = 120 lakh. This already includes retained earnings, so reserves are not added again. Preference 10 lakh and debt 30 lakh are at par. Total = 160 lakh.
  6. Weighted amounts: equity 120 × 16 = 1,920. Preference 10 × 12 = 120. Debt 30 × 7 = 210. Sum = 2,250.
  7. WACC = 2,250 ÷ 160 = 14.0625%, which is about 14.06%.
  8. Interpretation: market-weight WACC is higher because the market gives more weight to equity, the costliest source.

Answer: WACC on book value weights = 12.90%. WACC on market value weights ≈ 14.06%.

Example 2

A firm has ₹40,00,000 equity share capital, ₹30,00,000 retained earnings, ₹20,00,000 10% preference shares issued at par and ₹50,00,000 12% irredeemable debentures issued at par. The equity share price is ₹50. The next dividend is expected to be ₹5 per share and dividends grow at 6% a year. The tax rate is 30%. Compute WACC on book value weights.

Show the solution
  1. Cost of equity: Ke = D1 ÷ P0 + g = 5 ÷ 50 + 0.06 = 0.10 + 0.06 = 16%.
  2. Retained earnings: no floatation or other adjustment is given, so Kr = Ke = 16%.
  3. Preference: Kp = 10% (issued at par, irredeemable, no tax adjustment).
  4. Debt: Kd = 12% × (1 − 0.30) = 8.4% (issued at par, so net proceeds equal face value).
  5. Book weights in ₹ lakh: equity 40, retained earnings 30, preference 20, debt 50. Total = 140.
  6. Weighted amounts: equity 40 × 16 = 640. Retained earnings 30 × 16 = 480. Preference 20 × 10 = 200. Debt 50 × 8.4 = 420.
  7. Sum = 640 + 480 + 200 + 420 = 1,740.
  8. WACC = 1,740 ÷ 140 = 12.43% (approximately 12.4286%).

Answer: WACC on book value weights ≈ 12.43%.

Exam tips

  • Look for the words 'book value', 'market value' or 'existing capital structure'. They fix the weights. If neither is stated, use book values and mention your assumption in one line.
  • If a question gives both book and market data, compute both WACCs. Comparing them is a favourite part of the question.
  • Always draw the table: source, amount, weight, cost, weighted cost. Examiners award marks for each column.
  • In MCQs, check that your answer lies between the cheapest and costliest source. This removes wrong options quickly.
  • Work out component costs first if they are not given. Many questions combine the cost of equity (dividend growth or CAPM) with WACC.

Practice questions from 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

What is the WACC formula in CA Intermediate?

WACC = Σ(weight × cost) for all sources, or (sum of amount × cost) ÷ total capital. Use after-tax cost for debt. Weights come from book or market values, as the question states.

Which is better, book value weights or market value weights?

Market value weights are generally preferred in theory because they show what investors currently pay. Book weights are easier and more stable, and are used when market prices are not given. Always follow the basis the question names.

What is the difference between WACC and marginal cost of capital?

WACC is the average cost of the existing or target mix of funds. Marginal cost of capital is the weighted cost of the additional funds raised next. Marginal cost can differ from WACC when new funds cost more than old funds.

Do I add retained earnings when using market value weights?

No. The market value of equity shares already reflects retained earnings. Add reserves separately only under book value weights.

Is WACC used as the discount rate for projects?

Yes, it is commonly used as the cut-off rate for projects with the same risk as the firm's existing business. A project that earns more than WACC adds value.