WACC, the weighted average cost of capital, is the return a company must earn to satisfy both its lenders and its shareholders. It's the discount rate for unlevered free cash flow.
WACC = E/(D+E) x cost of equity + D/(D+E) x cost of debt x (1 - tax rate)
- Cost of equity comes from CAPM, the capital asset pricing model: risk-free rate + beta x equity risk premium. Beta measures how much the stock moves with the market.
- Cost of debt is what the company would pay to borrow today. Multiply it by (1 - tax rate) because interest is tax deductible.
- Weights use market values: equity is share price x diluted shares, and debt is usually taken at book value.
A private company has no share price and no beta, so you borrow betas from listed peers. Their betas include the effect of their own debt, so unlever each one, take the median, then relever it at your company's debt level:
unlevered beta = levered beta / (1 + (1 - tax rate) x D/E)