What is WACC?
A core Valuation interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
WACC — the weighted average cost of capital — is the blended return a company must earn to satisfy all of its capital providers. You weight the cost of equity and the after-tax cost of debt by their proportions of the capital structure at market values: WACC = E/V × Re + D/V × Rd × (1 − t). Debt is taken after tax because interest is tax-deductible. In a DCF, WACC is the discount rate for unlevered free cash flows: the rate must match cash flows that belong to all investors, which is why you discount FCFF — not levered cash flows — at WACC.
WHAT INTERVIEWERS LISTEN FOR
- ✓Blended required return of ALL capital providers — equity and debt
- ✓Weights at market values, not book values
- ✓Cost of debt is after tax (interest tax shield): Rd × (1 − t)
- ✓Pairs with unlevered free cash flow (FCFF) in a DCF — consistency of rate and flows
COMMON MISTAKES
- ✗Using book-value weights for the capital structure
- ✗Discounting levered cash flows (FCFE) at WACC — mixing investor perspectives
You've seen the model answer. Now get graded on yours.
In the interview you won't have this page — you deliver your version on a clock. Practice this and 1,000+ questions with AI feedback on every answer.
CORE QUESTIONS IN THIS CLUSTER
- Walk me through a DCF.
- How do you calculate WACC?
- What is EBITDA?
- What is enterprise value?
- What is the difference between Enterprise Value and Equity Value?
- What is the difference between the Gordon Growth Model and the Exit Multiple Method for terminal value?
- Walk me through the three financial statements and how they connect.
RELATED QUESTIONS
- What happens to the DCF value if you increase WACC by 1%?
- How do you calculate Beta for a private company?
- Should you use mid-year or year-end convention in a DCF?
- How do you handle negative cash flows in a DCF?
- What discount rate would you use for a highly leveraged company?
- A company has negative working capital because it collects cash from customers upfront but pays suppliers later. How does this affect your DCF valuation, and what trap must you avoid when projecting free cash flows?