How to Answer “How do you calculate WACC?” in Investment Banking Interviews

Start with a one-line definition and where it shows up in a DCF: WACC is the blended required return for all providers of capital—equity and debt—used to discount unlevered free cash flows.

Then give the formula cleanly:

• WACC = (E/(D+E)) × Re + (D/(D+E)) × Rd × (1−T)

Where Re is cost of equity, Rd is pre-tax cost of debt, and T is the marginal tax rate (interest is tax-deductible).

Add the key practitioner point: weights should be market-value or target capital structure weights, because WACC is a market required return. Mention book weights only as a rough proxy when market values aren’t available and you’ve sanity-checked the impact.

For most analyst interviews, use CAPM:

• Re = Rf + β × ERP

Explain each input briefly and practically:

• Risk-free rate (Rf): a long-term government bond yield in the same currency as the cash flows (consistency matters).
• Beta (β): typically derived from comparable companies—unlever their equity betas to get an asset beta, take a central tendency, then relever to the company’s target leverage.
• Equity risk premium (ERP): a house/market assumption for the expected excess return of equities over the risk-free rate.

If you mention adjustments (country risk, size), frame them as case-dependent. The goal is to show you know the standard approach and the workflow behind it, not to over-engineer the answer.

Cost of debt is the market rate the company would pay on incremental borrowing.

Common WACC calculation methods:

• If debt trades: use the current yield/YTM on bonds or an observable borrowing rate on the company’s curve.
• If no traded debt: infer an appropriate credit spread from rating/interest coverage or leverage versus comparable issuers, then estimate Rd ≈ Rf + spread.

Then convert to after-tax cost of debt:

• After-tax Rd = Rd × (1−T)

Use the marginal tax rate relevant to the forecast period (and be ready to explain why the historical effective rate may be distorted by one-offs, NOLs, or jurisdiction mix). Close with a quick reasonableness check versus peers’ borrowing costs for similar risk/leverage.

State how you set E and D in a model:

• Equity (E): market capitalisation (share price × diluted shares).
• Debt (D): ideally market value of debt; in practice, book value is often used as a proxy unless the debt is meaningfully off-par.

Then clarify when you use current vs target weights:

• Use current market weights when the capital structure is stable.
• Use a target capital structure when leverage is changing, the company is moving toward a peer norm, or you’re building a steady-state DCF.

Finally, plug the inputs into the formula and do a quick plausibility check: does the output match business risk and sector norms, and does it move the right way if leverage or beta changes?

Finish by tying WACC to what the interviewer cares about: valuation sensitivity.

Mention two or three checks that show you can defend your discount rate:

• Peer check: compare your implied WACC drivers (beta, spreads, leverage) to comparable companies.
• Terminal value check: in a perpetuity method, ensure WACC > terminal growth rate and that the spread is sensible.
• Sensitivity table: small moves in WACC can swing enterprise value materially, so you run a range around WACC and terminal assumptions.

If asked for a quick number example, keep it mental-math friendly (e.g., 70/30 weights). This keeps the answer grounded in how you’d actually work through a DCF under time pressure.