WACC is the blended after-tax cost of a company's debt and equity capital, weighted by their share in the capital structure. It is the discount rate used in DCF valuation to bring future free cash flows to present value, and it is the hurdle rate that ROIC must beat for the business to create value.
Formula: WACC = (E/V) × Ke + (D/V) × Kd × (1 − t), where E = market value of equity, D = market value of debt, V = E + D, Ke = cost of equity, Kd = cost of debt, t = marginal tax rate. The (1 − t) factor reflects that interest is tax-deductible.
Cost of equity (Ke) is typically estimated via CAPM: Ke = risk-free rate + beta × equity risk premium. For Indian large caps, Ke commonly runs 12-14% (risk-free ~7%, ERP 5-7%, beta near 1). Cost of debt (Kd) is the marginal interest rate the company would pay on new debt, after tax. Indian investment-grade Kd post-tax is ~6-7%.
Blended WACC for an Indian large-cap balance sheet typically sits at 10-12%; for high-leverage names with risky debt, WACC can be 14-16%. WACC is sensitive to capital structure: more debt reduces WACC up to a point (because debt is cheaper than equity post-tax) but increases distress risk beyond that point.
Example 1: A consumer goods company has equity worth Rs 80,000 cr and debt of Rs 5,000 cr. Ke = 13%, Kd = 7%, tax rate 25%. WACC = (80/85) × 13% + (5/85) × 7% × (1 − 0.25) = 12.24% + 0.31% = 12.55%. With ROIC of 30%, the business creates 17%+ excess return per unit of capital.
Example 2: An infrastructure company at Rs 10,000 cr equity, Rs 40,000 cr debt, Ke 18% (higher risk), Kd 9%. WACC = (10/50) × 18% + (40/50) × 9% × (1 − 0.25) = 3.6% + 5.4% = 9.0%. Lower WACC than the FMCG above, but ROIC is also lower; value creation is marginal.
WACC is sensitive to assumption inputs; sensitivity tables (±1% Ke, ±1% Kd) are best practice for DCF outputs.
Disclaimer: Educational content from MintByte (ARN-314872, MFD). Examples are illustrative. SEBI Investment Adviser registration is in process; we do not recommend specific stocks.