The WACC formula, weighting debt and equity
WACC = (E/V × Re) + (D/V × Rd × (1 - T))
Where E is the market value of equity, D is the market value of debt, and V = E + D. Re is the cost of equity (what shareholders demand). Rd is the cost of debt (the interest rate the company pays). T is the corporate tax rate — interest is tax-deductible, meaning the company subtracts interest payments from taxable income, so the real cost of debt is lower than the headline rate. The "weighted" part is the key word: a company that's 80% equity and 20% debt has a cost of capital much closer to its cost of equity than to its cost of debt.
Why the discount rate drives the whole valuation
Plug WACC into a valuation model and here's what happens: a company's intrinsic value — what the business is fundamentally worth, separate from its current stock price — is the present value of its future cash flows. "Present value" — what a future dollar is worth today, after accounting for risk and time — requires a discount rate. That discount rate IS the cost of capital. If you use 7%, the company looks valuable. If you use 10%, the same cash flows look 25–35% less valuable. The cost of capital is not a fact — it's an estimate, and the estimate drives the answer.
Estimate a cost of equity yourself
Pitfall: the discount rate is a judgment call
Two analysts looking at the same company can defensibly choose discount rates 200 basis points apart (a basis point is one-hundredth of a percent, so 200 basis points equals 2 percentage points). The lower rate makes the stock look like a buy; the higher rate makes it look fairly valued. This is why DCF (discounted cash flow, the valuation model val-4 introduces next) models are useful for thinking but dangerous as conviction-machines — small changes in the discount rate move the price target massively. When you see an analyst report citing a DCF-derived target, ask what discount rate was used and why. If the answer is "WACC," ask what cost of equity and cost of debt went into it. When you need the full mechanics — beta, CAPM, the after-tax debt math, capital-structure trade-offs — see dcf-3 "WACC: The Discount Rate That Makes or Breaks Your Model" and the corpval-wacc-301 series (Cost of Equity / Cost of Debt / M-M / Unlever-Relever / Capital Structure).
Sit with the ideas.
A company has $200M of equity (cost of equity 10%) and $50M of debt (cost of debt 6% before tax, 4.5% after tax at 25% corporate rate). What is the WACC?