Updated for the 2026-2027 CFA® Level I curriculum.
Weighted-average cost of capital, or WACC, is the blended required return a company owes across all its sources of financing. It matters in Corporate Issuers because companies use it to evaluate whether a project or investment creates value. On the exam, you must calculate WACC from given weights and costs, and interpret what a change in WACC means for a company's investment decisions.
Quick Answer
WACC is the weighted average cost of a company’s equity, debt, and preferred stock, using market-value weights.
Debt receives an after-tax adjustment because interest expense is generally tax deductible. A lower WACC means a lower overall cost of financing and a lower hurdle rate for new investments.
Key Takeaways
WACC is the blended required return across debt, preferred stock, and common equity, weighted by market value.
The standard formula applies an after-tax adjustment to the cost of debt, not to equity or preferred stock.
Weights must reflect market values of each financing source, not book values from the balance sheet.
WACC often serves as the discount rate for evaluating average-risk projects.
A project with returns below WACC destroys value; a project with returns above WACC creates value.
Changing a company's financing mix changes its WACC, even if component costs stay the same.
This note covers calculation and interpretation only. Estimating each component cost is covered separately.
What You Need to Know for CFA Level I
Calculate WACC given market-value weights and component costs for debt, preferred stock, and equity.
Apply the after-tax adjustment to the cost of debt using the marginal tax rate.
Identify market-value weights when both book and market values are given in a problem.
Interpret a rising or falling WACC in terms of financing cost and investment hurdle rate.
Recognize when WACC is an appropriate discount rate for a project and when it is not.
Distinguish WACC from the individual costs of debt, equity, and preferred stock used to build it.
What Is Weighted-Average Cost of Capital?
WACC is the average rate of return a company must earn on its assets to satisfy all of its investors, debtholders, preferred shareholders, and common shareholders. Each source of capital has a different cost and a different weight in the company's financing structure. WACC combines them into one rate.
This rate matters because it represents the company's overall cost of funding. Companies compare a project's expected return against WACC to decide whether the project adds value. A company financed mostly with cheap debt has a lower WACC than a company financed mostly with expensive equity, holding other factors equal.
WACC Formula
Where:
= market value of common equity
= market value of debt
= market value of preferred stock
, the total market value of the firm's financing
= cost of common equity
= pre-tax cost of debt
= cost of preferred stock
= marginal tax rate
The debt term is the only one adjusted for taxes. Interest payments are tax deductible, so the effective cost of debt to the company is lower than the stated pre-tax rate.
How to Calculate WACC Step by Step
Identify the market value of each financing source. Use market value, not book value, for debt, preferred stock, and equity.
Calculate the total market value . Add the market values of debt, preferred stock, and equity.
Calculate the weight of each source. Divide each component's market value by .
Apply the after-tax adjustment to the cost of debt. Multiply the pre-tax cost of debt by .
Multiply each weight by its component cost. Do this for debt, preferred stock, and equity separately.
Add the three weighted costs together. The sum is WACC.
Component costs, such as cost of equity from the CAPM or dividend discount model, and cost of debt from yield to maturity, are estimated in a separate step covered on the component-cost note. This note assumes those costs are already given.
How to Interpret WACC
A lower WACC means the company can fund projects more cheaply and has a lower hurdle rate to clear. A higher WACC means financing is more expensive, so fewer projects will appear attractive.
WACC works as the discount rate for evaluating a project only when the project has similar risk to the company's existing operations and uses a similar financing mix. A project riskier than the company's average business should use a higher discount rate than WACC. A project safer than the company's average business should use a lower rate. The 2026 curriculum does not require you to build a custom project-specific WACC at Level I, so use the given WACC unless a problem states otherwise.
When comparing two companies, the one with the lower WACC is not automatically the better investment. Weights and component costs both drive the result, and financing mix reflects business risk, industry, and capital structure choices as well as cost.
Worked WACC Example
Scenario. Ferrington Manufacturing has the following market values and costs of capital:
Component | Market Value | Cost |
|---|---|---|
Debt | $40 million | 6% (pre-tax) |
Preferred stock | $10 million | 7% |
Common equity | $50 million | 12% |
Ferrington’s marginal tax rate is 25%.
Step 1: Calculate Total Market Value
Add the market values of debt, preferred stock, and equity.
Step 2: Calculate the Capital Structure Weights
Debt weight:
Preferred stock weight:
Equity weight:
Step 3: Calculate the After-Tax Cost of Debt
Apply the marginal tax rate to the pre-tax cost of debt.
Step 4: Calculate the Weighted Component Costs
Debt:
Preferred stock:
Equity:
Step 5: Calculate WACC
Add the weighted costs of debt, preferred stock, and equity.
Therefore, Ferrington’s WACC is 8.50%.
Interpretation. Ferrington needs to earn at least 8.5% on its average-risk investments to satisfy its debtholders, preferred shareholders, and common shareholders. A project expected to return 10% clears this hurdle and adds value. A project expected to return 7% falls short and would reduce firm value if funded with this same financing mix.
Common Exam Traps
Using book values instead of market values
Problems sometimes give balance sheet figures alongside market prices. Always use market value of debt, preferred stock, and equity to calculate weights unless the question specifically states to use book value.
Forgetting the after-tax adjustment on debt
Only the cost of debt gets multiplied by . Applying the tax adjustment to preferred stock or equity is a common and costly mistake.
Double-counting a financing source
If a company has multiple debt issues or classes of stock, combine them into one weight per category before applying the formula. Do not run the formula twice for the same source.
Applying a project-specific risk adjustment without support
Level I problems typically want the straightforward company-level WACC unless the question explicitly asks you to adjust for project risk.
Re-deriving cost of equity or cost of debt
This note assumes those inputs are given. Estimating them with CAPM, bond yields, or dividend growth models is a separate skill on its own study note.
Practice Question
Bramwell Industries has the following market-value capital structure: debt of $30 million with a pre-tax cost of 8%, preferred stock of $20 million with a cost of 9%, and common equity of $50 million with a cost of 14%. Bramwell's marginal tax rate is 30%.
What is Bramwell's WACC?
10.48%
11.30%
9.80%
Correct Answer: A. 10.48%
Total market value = $100 million.
Debt weight = 0.30, preferred stock weight = 0.20, and equity weight = 0.50.
After-tax cost of debt:
Weighted cost of debt:
Weighted cost of preferred stock:
Weighted cost of equity:
WACC:
Therefore, the company’s WACC is 10.48%, so the correct answer is A.
Option B. 11.30% results from forgetting the after-tax adjustment on debt and using the pre-tax cost of 8% directly.
Option C. 9.80% results from applying the tax adjustment to preferred stock as well as debt, which understates the correct WACC.
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FAQs About Weighted-Average Cost of Capital
What is the WACC formula?
WACC is the weighted average of a company’s cost of equity, after-tax cost of debt, and cost of preferred stock, based on their market-value weights.
Where , , and are the market values of equity, debt, and preferred stock, , and t is the marginal tax rate.
Why does WACC use market value instead of book value?
Market value reflects what investors currently require to hold each type of security. Book value reflects historical accounting entries and does not represent current financing cost.
Is WACC the same as the cost of equity?
No. Cost of equity is only one input into WACC. WACC blends the cost of equity with the after-tax cost of debt and the cost of preferred stock, weighted by their share of total financing.