Answers / M&A Advisory

How do you calculate WACC?

A core M&A Advisory interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.

THE SHORT ANSWER

WACC is the blended required return across the capital structure: WACC = (E/V)·Re + (D/V)·Rd·(1−T), where E and D are the market values of equity and debt, V = E+D, T is the marginal tax rate (debt is after-tax because interest is deductible). The cost of equity Re comes from CAPM: risk-free rate + beta × equity risk premium, with a size premium and any specific-risk premium for smaller/private firms; beta is taken from comparable companies, unlevered to strip out their leverage and relevered at the subject's target capital structure. The cost of debt Rd is the current marginal borrowing cost (yield on debt given the rating), not the coupon on old debt. Use market-value weights and a target/sustainable capital structure, not book values or a transient mix. For a European mid-market business you'd often land around 8–11%. Common errors: book-value weights, the wrong (legacy) cost of debt, or forgetting to unlever/relever beta.

WHAT INTERVIEWERS LISTEN FOR

  • ✓WACC = (E/V)Re + (D/V)Rd(1−T), market-value weights
  • ✓Re via CAPM: Rf + β×ERP (+ size/specific); unlever/relever beta to target structure
  • ✓Rd = current marginal cost of debt (not old coupon); debt after-tax
  • ✓Use target/sustainable structure, not book or transient mix

COMMON MISTAKES

  • ✗Book-value weights
  • ✗Legacy coupon instead of marginal cost of debt
  • ✗Not unlevering/relevering beta

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