Cost of Equity & WACC
The Discount Rate That Makes or Breaks Every DCF
The Weighted Average Cost of Capital (WACC) is the rate at which all future cash flows are discounted in the DCF model — and therefore one of the two most influential assumptions in business valuation. Equitest derives WACC from first principles using both CAPM and the Build-Up Method, with every component sourced, disclosed, and editable.
What Is WACC and Why Does It Matter?
The Weighted Average Cost of Capital represents the blended required return of all providers of capital to a business — equity investors and debt holders — weighted by the proportion of each in the company's target capital structure. It is the rate at which the DCF model discounts future cash flows: a higher WACC means lower present value; a lower WACC means higher present value.
WACC is computed from two components: the cost of equity (what equity investors require, computed via CAPM or the Build-Up Method) and the after-tax cost of debt (the interest rate on debt, net of the tax shield). These are weighted by the proportions of equity and debt in the firm's capital structure — typically the target or industry-average structure rather than the current book value mix.
For private company valuations, where no observable market beta exists, Equitest uses industry-average betas from public comparables (unlevered and re-levered to the subject company's capital structure) and the Build-Up Method as a parallel check. Both results are shown side by side — giving the analyst a grounded, defensible WACC range rather than a single potentially spurious point estimate.
The WACC Formula
How Equitest Derives WACC
Chapter 21 is a full cost-of-capital derivation engine — not a single input field. Every component is sourced, calculated, and disclosed with the full methodology shown.
Beta-Based Cost of Equity via CAPM
Equitest derives a levered beta by starting from the Damodaran industry-average unlevered beta for the company's sector, then re-levering it to the subject company's capital structure using the Hamada equation. The levered beta is multiplied by the ERP from Chapter 20, with the risk-free rate and any applicable CRP added, to produce the CAPM cost of equity. All inputs are shown and sourced; the beta can be overridden with a custom value with mandatory rationale.
Additive Premium Stack for Private Companies
The Build-Up Method is the standard cost-of-equity approach when no reliable beta is available — the typical situation for private SMEs. Equitest constructs the full premium stack: risk-free rate + ERP + CRP + size premium + industry risk premium + company-specific risk premium (CSRP). The CSRP is analyst-entered and includes guidance on appropriate ranges for typical risk factors: key-person dependency, customer concentration, competitive position, and financial condition.
After-Tax Cost of Debt with Tax Shield
The pre-tax cost of debt is entered from the company's existing debt facilities or estimated from a synthetic credit rating based on interest coverage ratios. The tax shield — Kd × (1 − t) — is applied using the marginal corporate tax rate for the subject company's jurisdiction, pre-loaded by country from Equitest's global tax rate database. The result is the after-tax cost of debt used in the WACC formula.
Target Capital Structure Weighting
WACC should be derived using the target (long-run) capital structure, not the current book value mix — because the valuation reflects the firm's expected future financing. Equitest uses the industry-average debt-to-equity ratio from Damodaran's sector data as the default target structure, with the option to override to a company-specific target. The chosen capital structure is disclosed in the report with its source and rationale.
CAPM vs. Build-Up Side-by-Side Output
Chapter 21 displays both the CAPM-derived WACC and the Build-Up WACC side by side, allowing the analyst to select the primary estimate and note the range. When the two methods produce similar results, confidence in the WACC is higher. When they diverge, the divergence warrants investigation and disclosure. The final WACC selected is carried forward into the DCF engine in Chapter 24 automatically.
Automatic Feed into DCF Discount Rate
The finalized WACC from Chapter 21 flows directly into the DCF model in Chapter 24 as the discount rate applied to all projected FCFs and the terminal value. It also feeds into the Sensitivity Analysis (Ch. 26) as the Y-axis variable in the WACC × terminal growth rate sensitivity matrix, and into Monte Carlo (Ch. 36) as the center of the WACC probability distribution. No manual re-entry at any stage.
