The Daily Technical #80: What is the formula to calculate the weighted average cost of capital (WACC)?

Good morning. Welcome to the 80th edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
How do you determine the risk-free rate?

To determine the risk-free rate, focus on the yield to maturity of default-free government bonds that match the cash flow's duration.

Due to liquidity issues with longer bonds, the 10-year US Treasury note yield is often used as the risk-free rate proxy for US-based firms.

Common Mistakes

1. Opting for bonds with liquidity issues, affecting reliability. Use widely traded bonds like the 10-year US Treasury note to avoid liquidity concerns and ensure a consistent measure.

2. Focusing on past yields. Use current yield data to ensure your risk-free rate aligns with present market realities and gives a relevant outlook.

TL;DR

• Risk-free rate is derived from yield to maturity of default-free government bonds matching cash flow duration.

• Lack of liquidity in longer bonds shifts preference to 10-year US Treasury notes.

• US-based firms typically use the 10-year Treasury yield as risk-free rate proxy.

TODAY’S QUESTION
What is the formula to calculate the weighted average cost of capital (WACC)?

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THAT’S A WRAP
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See you tomorrow,

Mike Lukasevicz
Founder @ HirePrep