The Weighted Average Cost of Capital (WACC) represents the minimum rate of return that a company must generate to meet the requirements of all its funders (shareholders and creditors).

Here is the detailed method to calculate it:

1. The general formula

The WACC is the weighted average of the cost of equity and the cost of debt (net of tax). The formula is as follows:

$\mathbf{WACC}=\mathbf{EQ}(\%)\times \mathbf{E}\left(\mathbf{ROE}\right)+\mathbf{D}(\%)\times {\mathbf{I}}_{\mathbf{D}}\times (1–\mathbf{T})$

Where:

• EQ (%): The share of equity in total financing.
• E(ROE): The expected return on equity (the cost of equity).
• D (%): The share of financial debt in total financing.
• I_D: The interest rate on the debt (cost of debt before taxes).
• T: The tax rate on profits (Corporate Tax).

2. Calculating the components

A. The Cost of Equity (E(ROE): unlike debt, this cost is not contractual but corresponds to a risk-based profitability requirement. It is generally calculated using the CAPM (Capital Asset Pricing Model):

$\mathrm{E}\left(\mathrm{ROE}\right)={\mathrm{R}}_{\mathrm{F}}+\mathrm{ß}\times \mathrm{EMRP}$

• RF (Risk-Free Rate): Yield on long-term government bonds (the price of time).
• ß (Beta): Systematic risk coefficient measuring the volatility of the security in relation to the market.
• EMRP: Equity Market Risk Premium (historical difference between the profitability of the equity market and the risk-free rate).

B. The Cost of Debt after tax (ID (1 – T)): the cost of debt for the company is lower than the nominal interest rate paid to banks because the financial expenses are deductible from the taxable income. The State therefore “subsidizes” part of this cost via tax savings.

C. Weights (EQ(%) and D(%) – Market values): to calculate the share of each resource, it is imperative to use market values (financial value) and not book values.
For equity: market capitalization is used. The reason for this is that the WACC is used to evaluate future investment decisions; If the company were to repay its shareholders today, it would do so at market value. If it did not have a profitable investment opportunity, it would return their funds to shareholders by buying back their shares at market value.
For debt: the actuarial value of the debt (often close to the nominal value) is used.

3. Numerical example

The following example illustrates the calculation:

• Financial structure: 50% Equity / 50% Debt.
• Cost of equity required: 10%.
• Interest rate on the debt: 6%.
• Tax rate (T): 33.33%.

Calculation:

1. Cost of debt after tax: 6% (1 – 33.33%) = 4%.
2. Weighted average: 50% 10% + 50% 4% = 5% + 2% = 7%.

The WACC is therefore 7%.

4. Important details

• Local WACC: For a project abroad, the WACC must be calculated using local parameters (local risk-free rate, local inflation, local debt rate) to discount cash flows expressed in local currency.
• Project-specific risk: If a project has a very different risk profile from that of the company (e.g. diversification), the group’s WACC (“single WACC”) should not be used, but a project-specific WACC should be calculated using a beta and debt structure comparable to those of the target sector.