WACC = Cost of Equity * % Equity + Cost of Debt * (1 – Tax Rate) * % Debt + Cost of Preferred Stock * % Preferred Stockįinding the percentages is basic arithmetic – the hard part is estimating the “cost” of each one, especially the Cost of Equity.
How to Calculate Discount Rate: WACC Formula “Capital” just means “a source of funds.” So, if a company borrows money in the form of Debt to fund its operations, that Debt is a form of capital.Īnd if it goes public in an IPO, the shares it issues, also called “Equity,” are a form of capital. The name means what it sounds like: you find the “cost” of each form of capital the company has, weight them by their percentages, and then add them up. Normally, you use something called WACC, or the “Weighted Average Cost of Capital,” to calculate the Discount Rate. The Discount Rate also represents your opportunity cost as an investor: if you were to invest in a company like Michael Hill, what might you earn by investing in other, similar companies in this market?
The Discount Rate represents risk and potential returns, so a higher rate means more risk but also higher potential returns. The Discount Rate goes back to that big idea about valuation and the most important finance formula: Premium Course Signup Discount Rate Meaning and Explanation