IB InterviewTechnical
How to calculate WACC
Describe the weighted average cost of capital inputs and when to adjust them.
Direct answer
Blend the after-tax cost of debt and cost of equity using the firm’s target capital structure to discount unlevered cash flows.
Step-by-step
Walk through the structured answer
1
Cost of equity
Apply CAPM: risk-free rate plus beta times market risk premium; adjust beta for leverage if needed.
2
Cost of debt
Use current marginal borrowing rate times (1 – tax rate); reflect mix of term loans, bonds, and revolver spreads.
3
Capital structure weights
Use market value weights for equity and debt (and preferred if present) aligned to the valuation scenario.
4
Calculate and sanity check
WACC = Ke * We + Kd * Wd; test sensitivity to beta, leverage, and tax rate; ensure it matches industry risk.
Pitfalls to avoid
- Using book value weights or stale capital structure data.
- Applying pre-tax cost of debt or ignoring current credit spreads.
- Not adjusting beta for leverage when comparing peers.
Follow-up angles
- When would you use APV instead of WACC?
- How does a country risk premium flow into WACC?
- Why does mid-year convention slightly change effective discount rates?
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