WACC (Weighted Average Cost of Capital) is the standard discount rate in DCF (Discounted Cash Flow) valuations. Here is how to use it correctly and what to do when textbook inputs aren't available.
WACC in DCF: the mechanics
In a DCF model: Value = Σ (Free Cash Flow_t / (1 + WACC)^t) + Terminal Value / (1 + WACC)^n
WACC represents the required return for the entire capital structure — both equity and debt holders. Discounting at WACC gives enterprise value; subtract net debt to get equity value.
Estimating WACC for early-stage companies
Private companies and startups lack public market data for cost of equity. Approaches:
CAPM approach: Cost of equity = Risk-free rate + β × (Market premium) - Risk-free rate: 10-year US Treasury yield (~4.5% in 2024) - Equity risk premium: 5–6% (Damodaran historical) - Beta: use comparable public company betas (0.8–1.5 for SaaS)
VC hurdle approach: use the fund's target IRR (25–40% for early stage) as the cost of equity. This reflects the actual required return for equity investors.
No debt (pre-revenue): WACC = cost of equity. No debt weighting needed.
Common WACC mistakes
- Using book value instead of market value for equity and debt weights
- Not adjusting for taxes on the cost of debt component
- Using WACC for highly levered or distressed companies — use adjusted present value (APV) instead when debt levels change significantly over time
Use the WACC calculator to compute your blended cost of capital for DCF analysis.