Finance · 2026-06-16 · 7 min read
Written and reviewed by Project Financial Advisor · FCA · CGMA · ACMA — Chartered Accountant
How to Calculate WACC and Cost of Equity (CAPM Formula)
Calculate WACC from financial statements and cost of equity with CAPM: beta, the risk-free rate and the equity risk premium, with a worked example.
Your discount rate is the single most powerful assumption in a valuation — a one-point change can move enterprise value by 15% or more. That rate is the weighted average cost of capital (WACC), and its hardest ingredient, the cost of equity, comes from the capital asset pricing model (CAPM). This guide builds both from the ground up with the formulas and a worked example.
What WACC actually is
A company is funded by equity and debt, and each demands a return. WACC blends them by weight: WACC = (E ÷ V) × Re + (D ÷ V) × Rd × (1 − tax rate). Here E is equity value, D is debt, V is E + D, Re is the cost of equity, and Rd is the cost of debt. Debt is multiplied by (1 − tax) because interest is tax-deductible — the 'tax shield' that makes debt cheaper than it first appears.
Cost of equity: the CAPM formula
Equity has no stated rate, so CAPM estimates it: Re = Rf + β × (Rm − Rf). Rf is the risk-free rate (a government bond yield), (Rm − Rf) is the equity risk premium — the extra return investors demand for holding stocks over bonds — and β (beta) measures how much the company moves relative to the market. A β of 1.0 moves with the market; above 1.0 is more volatile and commands a higher required return.
| Input | Value | Note |
|---|---|---|
| Risk-free rate (Rf) | 4.0% | 10-year government bond |
| Beta (β) | 1.20 | 20% more volatile than market |
| Equity risk premium | 5.5% | Market return minus Rf |
| Cost of equity (Re) | 10.6% | 4.0% + 1.20 × 5.5% |
Putting WACC together
Take the CAPM cost of equity, add the after-tax cost of debt, and weight them by the capital structure. Suppose the firm is 70% equity and 30% debt, cost of debt is 6%, and tax is 25%: WACC = 0.70 × 10.6% + 0.30 × 6% × (1 − 0.25) = 7.42% + 1.35% = 8.77%.
Why capital structure matters
Because debt is cheaper than equity, adding modest leverage lowers WACC and raises valuation — up to a point. Too much debt raises the risk of distress, which pushes up both the cost of debt and equity and reverses the benefit. This trade-off is why WACC is an assumption to reason about, not a fixed constant.
Common CAPM pitfalls
Watch three traps: using a short-term T-bill instead of a long-dated bond for the risk-free rate (mismatch with long-horizon cash flows); pulling a raw beta without considering the company's actual leverage; and forgetting the tax shield on debt. Each quietly distorts the discount rate and therefore the valuation.
Let the model do the maths
How capital structure shifts WACC
Because after-tax debt is cheaper than equity, adding modest leverage lowers WACC. A firm at 100% equity with a 10.6% cost of equity has a WACC of 10.6%; shift to 30% debt at a 4.5% after-tax cost and WACC falls to about 8.8%. But push leverage too far and the rising risk of distress lifts both the cost of debt and the cost of equity, so WACC turns back up — the trade-off that defines an optimal capital structure.
EasyFinancialModels lets you enter WACC directly or build it through CAPM — risk-free rate, beta and equity risk premium — with every input visible in the Excel workbook and flowing straight into the DCF valuation. Free for a 3-year model, no account needed.
CAPM vs WACC: what's actually the difference
The two get spoken of as rivals, but they are stages of one calculation. CAPM answers a single question — what return do equity investors require for this risk? WACC then takes that answer and blends it with the after-tax cost of debt, weighted by how the company is actually funded. The confusion has one honest source: for an all-equity company the two numbers are identical, because with no debt to blend, WACC collapses to the CAPM cost of equity.
| CAPM | WACC | |
|---|---|---|
| What it measures | Required return on equity only | Blended return across all capital |
| Formula | Ke = Rf + β × ERP | (E/V) × Ke + (D/V) × Kd × (1 − tax) |
| Key inputs | Risk-free rate, beta, equity risk premium | CAPM output, cost of debt, capital weights |
| Where it's used | Equity DCF; input to WACC | Enterprise DCF discount rate |
The size premium: adjusting CAPM for smaller companies
Textbook CAPM systematically understates the returns small companies must offer — decades of market data show small firms outperforming what their betas predict. Valuers correct this with a size premium added on top: Ke = risk-free rate + beta × ERP + size premium, sometimes with a further company-specific premium for concentration or key-person risk. For a small private business the size premium commonly adds 3–6 points, which is how a company whose CAPM output says 10.6% ends up being valued at a 15–17% cost of equity. Skipping it is the single most common way small-business valuations come out too high.
Running the numbers: a WACC calculator in Excel
You can wire the formulas into a spreadsheet in ten minutes — or skip the wiring. The free WACC calculator computes the capital weights, the after-tax cost of debt and the blended rate in the browser, and the CAPM calculator builds the cost of equity from your risk-free rate, beta and premium. Generate a full model and the same WACC/CAPM machinery is written into the Excel workbook as live formulas, feeding the DCF directly — so the discount rate and the valuation always move together.
Related: WACC calculator · CAPM cost of equity calculator · unlever and relever beta · DCF valuation model
Frequently asked questions
What is the difference between WACC and CAPM?
CAPM estimates the cost of equity alone. WACC blends that cost of equity with the after-tax cost of debt, weighted by capital structure, to give the overall discount rate used in valuation.
Why is a higher WACC bad for valuation?
Future cash flows are divided by (1 + WACC)^n, so a higher discount rate shrinks their present value and lowers enterprise value. A one-point WACC change can move value by more than 10%.
What is a typical WACC?
Most established companies fall between 7% and 12%; early-stage or high-risk businesses run 15–25%. Capital-intensive infrastructure is often 9–12%.
What is the size premium in WACC?
An addition to the CAPM cost of equity reflecting that small companies have historically returned more than their beta predicts. Practitioners add roughly 3–6% for small private businesses in a build-up: Ke = risk-free rate + beta × ERP + size premium, which flows into a higher WACC.
Is there a free WACC calculator for Excel?
Yes — the EasyFinancialModels WACC calculator computes equity and debt weights, the after-tax cost of debt and blended WACC in the browser, and the generated financial model writes the same WACC/CAPM formulas into a linked Excel workbook, free for a 3-year model.
→ Build your dcf & valuation model free with the DCF Valuation tool
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About the author
Every model is built and reviewed by the project's Financial Advisor — a Fellow Chartered Accountant (FCA) of the Institute of Chartered Accountants of Pakistan (ICAP), Chartered Global Management Accountant (CGMA) and Associate Chartered Management Accountant (ACMA) with around two decades of corporate finance, audit and accounting experience, designing investor-grade financial models across industries. Full credentials and background are available on LinkedIn. More about the author →
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