What is WACC, and why does it change company value so much?
WACC — Weighted Average Cost of Capital — represents the blended expected return required by a company’s equity and debt capital providers.
Why does capital have a cost?
Equity investors require a return because they accept business risk. Lenders require interest because they provide financing. WACC combines these required returns into one weighted rate.
Basic formula
WACC = E/(D+E) × Ke + D/(D+E) × Kd × (1−T)
- E = market value of equity;
- D = market value of interest-bearing debt;
- Ke = cost of equity;
- Kd = cost of debt;
- T = tax rate.
Why does a higher WACC reduce value?
DCF discounts future cash flows using a rate linked to WACC. The higher the discount rate, the lower the present value of the same future cash flow.
Economically, that makes sense: investors demand a higher return from a riskier business, so they are willing to pay less today for the same expected future cash generation.
Cost of equity
A common CAPM-style formulation is:
Ke = risk-free rate + beta × equity risk premium + relevant additional risk premiums
Country risk, size and company-specific risk may need separate treatment depending on the valuation context.
Why is WACC difficult for private SMEs?
A private Hungarian SME has no directly observable listed beta or market-value capital structure. Analysts therefore rely on industry benchmarks, target capital structure and documented market data.
One of the weakest valuation practices is choosing a convenient round-number WACC without a defensible source or logic.
Why sensitivity analysis matters
WACC is an estimate, not a physical constant. A robust valuation should show how value changes if WACC is, for example, one percentage point higher or lower.
GlobalTaxAI approach
GlobalTaxAI constructs WACC from documented market inputs, including industry beta and target capital structure, and separately presents WACC–terminal-growth sensitivity.