WACC Calculations in Practice: Incorrect Results due to Inconsistent Assumptions - Status Quo and Improvements

Abstract

This paper argues that in practical applications the weighted average cost of capital (WACC) is often incorrectly estimated due to the simultaneous use of two inconsistent input parameters: (i) a beta of debt equal to zero when transforming asset betas into equity betas (beta levering) and (ii) a cost of debt above the risk-free interest rate when calculating the WACC. The paper discusses and quantifies the consequences of this inconsistency and offers viable solutions. By replacing the cost of debt with the risk-free rate, a more accurate WACC is calculated and the estimation of the cost of debt becomes obsolete. Furthermore, the paper presents a solution to obtain the correct WACC without increasing the calculation’s complexity.