WACC: drag the debt mix
Drag the handle to set how much of a fixed pile of capital is debt. Equity fills the rest. The headline is WACC, with both input costs held still. Tilt toward debt and the blend falls, because this picture does not reprice the equity as the mix gets riskier.
WACC
6.90%
After-tax cost of debt
3.75%
Equity is $6,000,000 at 9 percent. Debt is 40 percent of the mix. Input costs are held still, which is the trick in a falling WACC. Illustrative arithmetic, not a hurdle or advice.
Total capital
$10,000,000, with equity filling whatever debt does not.
In short
- Drag the handle right for more debt, left for more equity.
- Read WACC, then the after-tax cost of debt, which does not move unless you change tax.
- Set debt to zero: WACC equals the cost of equity.
- Focus the handle and use the arrow keys to step the mix.
A blend, not a coupon
WACC weights the cost of equity and the after-tax cost of debt by the share of capital each supplies. How WACC works is the identity, with the WACC calculator under the answer.
Interest usually counts as a cost of doing business, so the debt term carries and the equity term does not. At a 25 percent tax rate, a 5 percent coupon costs 3.75 percent once the deduction is counted.
Holding the costs fixed is the trick
On this picture the cost of equity and the cost of debt do not climb as you add debt. That is what makes the fall look free. Every extra dollar borrowed puts a fixed claim ahead of the shareholders, so the cost of equity rises with the leverage ratio. Lenders watching cover thin out want more as well.
Use market values, not the balance sheet. Book value is not a stand-in for market equity.
The rate a DCF actually uses
WACC is the rate a company discounts its own unlevered cash flows at. How DCF works is that present value. Mix a nominal WACC with a forecast written in today's prices and inflation is counted twice. Cost of capital is the surrounding idea.
Common questions
Why does more debt lower WACC here?
Because the input costs are held still, and after-tax debt is the cheaper source. In a live firm those costs climb as the mix gets riskier, and the two effects pull against each other.
Which tax rate goes in?
The marginal rate on the profit the interest actually shelters. Where there is no deduction, set the rate to zero and the debt term costs its full coupon.
Is this the hurdle I should use?
No. It is a blend on a teaching sheet with costs held still. It is educational material, not advice.
Keep reading
This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.