Weighted Average Cost of Capital (WACC)
The average rate of return required by all providers of capital in a business (debt and equity), weighted by their respective share of the financing structure.
Definition
The weighted average cost of capital (WACC) is the minimum rate of return a business must generate to satisfy both its lenders and its shareholders. It combines the cost of debt (the interest rate on borrowings, after tax shield) and the cost of equity (the return expected by shareholders), each weighted by its share of the capital structure.
In French-language Quebec documentation, you’ll see CMPC (coût moyen pondéré du capital) used for the same concept.
In business valuation, WACC is mainly used as the discount rate in the discounted cash flow (DCF) method. It brings future cash flows back to their present value. The higher the WACC, the lower the present value of future flows — and therefore the lower the estimated value of the business.
Why WACC matters in a business sale
WACC directly influences the valuation of your business. When a buyer or a valuator uses the DCF method, the discount rate chosen — often based on WACC — determines how much weight is given to future cash flows.
A WACC of 10% instead of 12% can meaningfully move the value of your business.
Several factors affect WACC and are partly outside the seller’s control. Prevailing interest rates in Canada influence the cost of debt.
Your business’s risk profile (revenue stability, customer concentration, owner dependency) drives the cost of equity. In periods of high interest rates, WACC mechanically rises and valuations tend to compress.
For a seller, understanding WACC helps interpret the offers you receive. If a buyer proposes a price below your expectations, it may be because they’re applying a high WACC in light of perceived risks in your business.
Reducing those risks before going to market (diversifying customers, documenting processes, strengthening the management team) can translate into a lower implicit WACC — and therefore a more favourable valuation.
What every seller should know
- WACC varies by sector: a recurring-services business will have a lower WACC than a project-based construction business, all else being equal.
- When interest rates are rising, business valuations face downward pressure — timing of sale can influence the value achieved.
- Reducing perceived risks in your business (owner dependency, revenue concentration, lack of contracts) lowers the implicit WACC and raises your valuation.
- You don’t need to calculate WACC yourself, but understanding the mechanism helps you ask your valuator or broker the right questions.