What is WACC and how do you calculate it?

WACC comes up in essentially every DCF conversation, and it's rarely asked once. The opening question is easy — state the formula — and then the interviewer starts pulling threads: where does beta come from, why do you unlever it, why after-tax cost of debt, why market values.

A discount rate is a blended required return: the cost of every dollar funding the business, weighted by how much of the funding each source provides. If you can hold that idea while you work through the components, the follow-ups become answerable rather than memorised.

Lead with the formula.

WACC = (E/V) × cost of equity + (D/V) × cost of debt × (1 − tax rate)

where E is equity value, D is debt, and V is E + D. Add a third term for preferred stock if the company has any (no tax adjustment — preferred dividends aren't deductible).

Then take the components in order.

Cost of equity, via CAPM: risk-free rate + beta × equity risk premium, plus a size or country premium where relevant. The risk-free rate is a long-dated government bond in the same currency as the cash flows — typically the 10-year or 20-year. The equity risk premium is usually taken from a published source and sits in the mid single digits.

Beta: here's the part interviewers actually care about. You don't take the target's observed beta and use it. You pull levered betas for a set of comparable companies, unlever each one to strip out the effect of its own capital structure:

βU = βL / [1 + (1 − t) × D/E]

take the median, then relever at the target's target capital structure. The logic is that beta as observed reflects both business risk and financial risk, and you only want the peers' business risk before layering on your company's leverage.

Cost of debt: the yield to maturity on existing traded debt, or a synthetic rate built from the company's credit rating or interest coverage. Multiply by (1 − t) because interest is tax deductible, so the government funds part of the cost.

Weights: market values, not book. Use the target capital structure the company is expected to run at, not necessarily today's — particularly relevant if the business is mid-recapitalisation or currently over-levered.

Finish with what it's for. WACC discounts unlevered free cash flow, because unlevered cash flow belongs to all capital providers. Levered free cash flow is discounted at the cost of equity.

Whether you understand the matching principle. Discount rate and cash flow must belong to the same claimholders. Discounting levered cash flow at WACC double-counts the benefit of debt, and it's the single fastest way to signal you've never built a DCF from scratch.

Whether beta is a memorised word or a process. "Beta measures volatility relative to the market" is a textbook definition, not an answer. Where you got it, why you unlevered it, and what capital structure you relevered at is the answer.

Whether you know a discount rate is an assumption, not a fact. Strong candidates volunteer that WACC is one of the two inputs a DCF is most sensitive to (the other being terminal growth), which is why every DCF output is presented as a sensitivity table rather than a single number.

Whether you'll follow a trap. The most common one: "debt is cheaper than equity, so should the company just use more debt?" Handle it well and the technical section usually moves on.