WACC: The Minimum Return a Company Must Earn

Concept

WACC (Weighted Average Cost of Capital) is the blended discount rate used in DCF analysis to convert future unlevered free cash flows into present value. It combines the returns required by both debt and equity investors, weighted by their proportions in the capital structure. Where Cost of Capital (see separate article) focuses on calculating each component, WACC is about blending them correctly and applying that blend as your discount rate. Get the blend wrong, and your entire valuation is off.

Intuition

WACC exists because companies fund themselves with a mix of debt and equity—and each has a different cost.

Imagine a company that's 60% equity (costing 10%) and 40% debt (costing 4% after-tax). The blended rate isn't 10%, and it isn't 4%—it's somewhere in between, weighted by how much of each the company uses.

This blended rate becomes your DCF discount rate because unlevered free cash flows belong to all capital providers. You're valuing cash flows before interest payments, so you discount at a rate that reflects everyone's required return—not just shareholders'. That's the matching principle: unlevered cash flows get a blended (WACC) discount rate; levered cash flows (after interest) would get an equity-only rate.

Components

Interview Script

WACC is the blended discount rate that combines the cost of debt and cost of equity, weighted by their proportions in the capital structure. We use it in DCF analysis because unlevered free cash flows belong to all capital providers—both debt and equity holders—so the discount rate needs to reflect everyone's required return, not just shareholders'. For example, a company that's 60% equity at 10% cost and 40% debt at 4% after-tax cost would have a WACC somewhere between those two rates.