Skip to content

Corporate Accounting and Financial Management · Cost of Capital

Weighted Average Cost of Capital (WACC) Formula and Numericals

Updated 11 October 2026 · Fact-checked

WACC is the overall cost of a firm's long-term funds. You find the after-tax cost of each source, multiply it by that source's weight in the capital structure, and add the results. Weights can use book values or market values. Market value weights are theoretically better.

Understand Weighted Average Cost of Capital (WACC)

A company raises money from several sources: equity shares, preference shares, debentures, term loans and retained earnings. Each source has its own cost. Debt is usually cheaper than equity. Equity is costlier because shareholders bear more risk.

You cannot judge a project by one source's cost, because the firm uses a mix of funds. WACC gives one single rate for that mix. It is the minimum return the firm must earn on its investments to keep its investors satisfied. That is why it is used as the discount rate in NPV and as the cut-off rate in IRR.

WACC is a weighted average, not a simple average. A source that supplies 60% of the funds must count for more than one that supplies 5%. Each cost is multiplied by its proportion in total capital, and the products are added.

The choice of weights matters. Book value weights use the figures on the balance sheet. They are easy to get and stable. Market value weights use current market prices of shares and debentures. They show what it would cost to raise funds today, so most textbooks prefer them. A related idea is marginal weights, which use the proportions of new funds to be raised.

Remember to use the after-tax cost of debt, because interest is tax-deductible. Preference dividend and equity dividend are not, so their costs are used as they are.

Key rules to remember

WACC
WACC = Σ (Wi × Ki) = (E × Ke + P × Kp + D × Kd(1 − t) + R × Kr) ÷ Total capital
Wi is the weight of each source and Ki its cost. Weights must add up to 1 or 100%.
Weight of a source
Weight = Value of the source ÷ Total value of all sources
Use book values or market values consistently for all sources.
After-tax cost of debt
Kd (after tax) = Interest rate × (1 − tax rate)
For irredeemable debt, Kd = I ÷ NP × (1 − t), where NP is net proceeds.
Cost of equity (dividend growth approach)
Ke = D1 ÷ P0 + g
D1 is the expected dividend next year. Use the figure the question gives you.
Cost of preference shares
Kp = Preference dividend ÷ Net proceeds (irredeemable)
No tax adjustment is made.
Cost of retained earnings
Kr = Ke (when no flotation cost or personal tax adjustment is given)
Treat retained earnings at the same cost as equity unless told otherwise.

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

Use the same sequence for every WACC question. It keeps your answer in order and earns step marks even if one number goes wrong.

  1. 1Read which weights the question asks for: book value, market value or marginal. If it does not say, state your choice and reason.
  2. 2List every source of long-term funds with its amount.
  3. 3Compute the cost of each source. Convert debt to after-tax cost using (1 − t).
  4. 4Calculate the weight of each source by dividing its value by the total.
  5. 5Multiply each cost by its weight to get the weighted cost.
  6. 6Add the weighted costs to get WACC.
  7. 7Write a one-line conclusion and state any assumption, such as treating retained earnings at the cost of equity.

Quickest way: Table method with amounts instead of fractions

When to use it: Use this when the question has 3 or 4 sources and round figures. It avoids long decimals.

  1. Draw a table with columns: source, amount, cost %, total cost (amount × cost).
  2. Fill the total cost column in rupees, not percentages.
  3. Add the amounts and add the total costs.
  4. Divide total cost by total amount and multiply by 100 to get WACC.
  5. If the question asks for both book and market weights, reuse the cost column and change only the amounts.

Common mistakes in Weighted Average Cost of Capital (WACC)

  • Using pre-tax cost of debt in the WACC

    Students see the interest rate in the question and plug it in directly.

    Fix: Always multiply by (1 − tax rate) before weighting, unless the question says the figure is already after tax.

  • Using book value of equity when market weights are asked

    The balance sheet figure is easier to find.

    Fix: For market weights, use number of shares × market price for equity and market price for debentures and preference shares.

  • Weights that do not add up to 100%

    A source is left out, or retained earnings are ignored.

    Fix: Add all amounts first and check that the total of weights equals 1 before multiplying.

  • Taking a simple average of the costs

    Students forget that sources differ in size.

    Fix: Always weight each cost by its share of total capital.

  • Treating retained earnings as free

    No dividend is paid on them, so they look costless.

    Fix: Shareholders expect a return on retained profits, so use the cost of equity.

  • Including current liabilities in the weights

    Students copy the full liabilities side of the balance sheet.

    Fix: WACC uses long-term sources only: equity, reserves, preference, debentures and term loans.

Worked examples

Example 1

A company has the following capital structure at book values: Equity share capital ₹6,00,000; 10% Preference share capital ₹2,00,000; 12% Debentures ₹4,00,000. Cost of equity is 15%. Tax rate is 25%. Debentures are issued and redeemable at par. Compute WACC using book value weights.

Show the solution
  1. Cost of equity Ke = 15%.
  2. Cost of preference Kp = 10% (issued at par, no tax adjustment).
  3. After-tax cost of debt Kd = 12% × (1 − 0.25) = 9%.
  4. Total capital = 6,00,000 + 2,00,000 + 4,00,000 = ₹12,00,000.
  5. Weighted cost of equity = 6,00,000 × 15% = ₹90,000.
  6. Weighted cost of preference = 2,00,000 × 10% = ₹20,000.
  7. Weighted cost of debt = 4,00,000 × 9% = ₹36,000.
  8. Total = 90,000 + 20,000 + 36,000 = ₹1,46,000.
  9. WACC = 1,46,000 ÷ 12,00,000 = 12.17% (approx.).

Answer: WACC = 12.17% approximately.

Example 2

Using the same company, the market values are: Equity ₹9,00,000; Preference ₹1,80,000; Debentures ₹3,60,000. Costs after tax remain Ke 15%, Kp 10%, Kd 9%. Compute WACC using market value weights and compare with the book value result.

Show the solution
  1. Total market value = 9,00,000 + 1,80,000 + 3,60,000 = ₹14,40,000.
  2. Equity weighted cost = 9,00,000 × 15% = ₹1,35,000.
  3. Preference weighted cost = 1,80,000 × 10% = ₹18,000.
  4. Debt weighted cost = 3,60,000 × 9% = ₹32,400.
  5. Total = 1,35,000 + 18,000 + 32,400 = ₹1,85,400.
  6. WACC = 1,85,400 ÷ 14,40,000 = 12.875%, which is 12.88% approx.
  7. Comparison: market weights give a higher WACC because equity, the costliest source, has a larger share at market value (62.5% against 50% at book value).

Answer: WACC at market value weights = 12.88% approximately, higher than 12.17% at book value weights.

Exam tips

  • Write the formula and the table first. Examiners give marks for the method even when arithmetic slips.
  • State clearly whether you used book or market weights and why. Mention that market weights reflect current conditions.
  • Check whether the question gives cost figures already after tax. Do not apply tax twice.
  • Use at least two decimal places in the final answer and show the weighted cost of each source.
  • Be ready for a theory part asking you to compare book and market value weights, so learn one or two points on each.

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 difference between book value and market value weights in WACC?

Book value weights use balance sheet amounts. Market value weights use current market prices of the firm's securities. Market weights show current financing conditions, but they change often. Book weights are stable and easy to compute.

Which weights should I use if the question does not specify?

Use market value weights if market prices are given, and say so. If only book values are given, use them and state that assumption. Either way, a clear statement protects your marks.

Why is cost of debt taken after tax in WACC?

Interest is a deductible expense, so it reduces the company's tax bill. The real cost to the company is interest × (1 − tax rate). Dividends are paid from profit after tax, so no such adjustment applies to them.

Is retained earnings included in WACC?

Yes. Retained earnings belong to equity shareholders and carry an opportunity cost. Unless the question gives a separate cost, treat them at the cost of equity.