WACC and CAPM: What Is BAR Actually Asking You to Calculate?
CAPM estimates the required return on equity. WACC blends the costs of the company's financing sources.
CAPM
Cost of Equity = Risk-Free Rate + Beta × Market Risk Premium
Market risk premium is commonly expected market return minus the risk-free rate.
Beta
Beta measures systematic risk relative to the market. A beta above 1 indicates greater sensitivity to market movements, while a beta below 1 indicates lower sensitivity.
WACC
A simplified debt-and-equity formula is: Weight of Debt × After-Tax Cost of Debt + Weight of Equity × Cost of Equity. Include other financing sources when the problem requires them.
Why debt is often after tax
Interest expense may produce a tax benefit under the standard framework, so after-tax cost of debt is often calculated as pre-tax cost of debt × (1 − tax rate).
Weights
Use the weighting basis required by the problem. Market-value or target weights are common finance concepts, but explicit facts control.
Common trap: coupon rate
The coupon rate on existing debt is not automatically the company's current cost of debt. A current market yield or borrowing cost may be more relevant when provided.
The takeaway
CAPM estimates equity cost. WACC combines financing costs into one required-return benchmark.
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FAQ
Does beta go directly into WACC?
Usually beta feeds CAPM, which estimates cost of equity, and that cost then feeds WACC.
Why multiply debt cost by one minus the tax rate?
To reflect the tax benefit of deductible interest under the standard WACC framework.
Should I use book or market weights?
Follow the problem. Market or target weights are common in finance calculations.