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Weighted average cost of capital

Edexcel IAL Accounting · WAC12 Corporate and Management Accounting

The discount rate for NPV should reflect what the company pays for its finance. When finance comes from several sources, the weighted average cost of capital (WACC) combines their costs in proportion to how much each provides.

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Calculating WACC

1. List each source of long-term finance with its value (market values where given, otherwise the amounts in the question).

2. Note the cost (required return) of each source as a percentage.

3. Multiply each value by its cost, add them, and divide by the total value:

WACC = sum of (value x cost) / total value x 100

or, equivalently, sum of (weight x cost) where weight = value / total value.

Worked example

Source	Value £	Cost	Weight	Weight x cost
Ordinary shares (market value)	6,000,000	11%	0.60	6.60%
7% preference shares	1,000,000	7%	0.10	0.70%
Debentures	3,000,000	6%	0.30	1.80%
Total	10,000,000		1.00	9.10%

Using WACC

WACC is the minimum return a project must earn to satisfy all providers of finance, so it is used as the discount rate in NPV.
Choosing funding for a new project: a cheaper source lowers WACC, but debt raises gearing and risk; equity avoids fixed interest but dilutes control.
Limits: costs are estimates, the mix of finance changes over time, and a risky project may need a higher rate than the company average.

In the June 2025 paper, WACC and the choice of funding opened a 55-mark project appraisal question.

Worked example

A company is financed by £4,000,000 of equity costing 12% and a £1,000,000 bank loan costing 7%. Calculate its WACC.

Equity: 4,000,000 x 12% = 480,000
Loan: 1,000,000 x 7% = 70,000
Total cost 550,000 / 5,000,000 x 100

Answer: WACC = 11%

Key idea: WACC = sum of (value of each source x its cost) / total value; it is the discount rate for NPV and the minimum acceptable return.

Check yourself

Equity £9,000,000 at 10% and debentures £3,000,000 at 6%. Calculate the WACC as a percentage.
Show answer
9.0 %. (900,000 + 180,000) / 12,000,000 x 100 = 9.0%.
Ordinary shares £5,000,000 at 13%, preference shares £2,000,000 at 8%, bank loan £3,000,000 at 7%. Calculate the WACC to 2 decimal places.
Show answer
10.20 %. (650,000 + 160,000 + 210,000) / 10,000,000 x 100 = 10.20%.
60% of a company's capital costs 12% and 40% costs 5%. Calculate the WACC.
Show answer
9.2 %. 0.6 x 12 + 0.4 x 5 = 9.2%.
A company has equity of £6,000,000 at 11% and debt of £2,000,000 at 5%. It raises a new £2,000,000 loan at 6%. Calculate its new WACC to 2 decimal places.
Show answer
8.80 %. (660,000 + 100,000 + 120,000) / 10,000,000 x 100 = 8.80%.
What is WACC used for in investment appraisal?
- As the payback period
- As the residual value
- As the discount rate for calculating NPV
- As the depreciation rate
Show answer
As the discount rate for calculating NPV. It is the minimum return required by the providers of finance.
Why does adding cheaper debt finance not always benefit shareholders?
- It raises gearing, increasing financial risk and possibly the cost of equity
- Debt interest is never tax-deductible
- Debt holders get votes
- Debt must be repaid immediately
Show answer
It raises gearing, increasing financial risk and possibly the cost of equity. Higher gearing increases risk to shareholders.

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Last updated 8 November 2026. Spotted a mistake? Tell us.