Discount Rate Calculator — Free Online Discount Rate Tool

How to Use the Discount Rate Calculator

This calculator computes the Weighted Average Cost of Capital (WACC) — the most widely used discount rate in corporate finance. WACC blends the cost of equity (estimated via CAPM) with the after-tax cost of debt, weighted by their proportions in the capital structure. Follow these steps for accurate results.

1. Enter the risk-free rate. This is typically the yield on the 10-year U.S. Treasury bond. The default of 4.0% reflects recent market conditions. For analyses involving other countries, use the local government bond yield. The risk-free rate is the foundation of the CAPM model: it represents the return available with zero default risk and sets the floor for all required returns.
2. Enter the equity risk premium. This is the additional return investors demand above the risk-free rate for investing in stocks. The historical U.S. average is approximately 5-6%, and the default of 5.5% is a commonly used mid-range estimate. Higher values are appropriate for riskier markets or during periods of elevated market uncertainty. Lower values may be suitable for very stable periods or low-volatility environments.
3. Enter the beta. Beta measures the systematic risk of a specific company relative to the overall market. A beta of 1.0 means the company moves with the market, greater than 1.0 means more volatile, and less than 1.0 means less volatile. You can find company betas on financial data services. For private companies, use comparable company betas adjusted for leverage differences.
4. Enter the cost of debt. This is the company's average borrowing rate on its outstanding debt. For public companies, you can estimate this by dividing annual interest expense by total debt outstanding, or by looking at the yield on the company's existing bonds. The default of 5.0% is a reasonable estimate for an investment-grade corporate borrower.
5. Enter the debt-to-capital ratio and tax rate. The debt ratio is the proportion of total capital that is financed by debt (debt / (debt + equity)). The corporate tax rate determines the tax shield benefit of debt interest deductions. The U.S. federal corporate rate is 21%, but state taxes may add 2-5%, and many companies have effective rates that differ from the statutory rate due to deductions and credits.

The calculator instantly computes the WACC, cost of equity (via CAPM), pre-tax and after-tax cost of debt, and shows the weighted contribution of each capital component. Use the WACC as the discount rate in DCF models, as a hurdle rate for capital budgeting decisions, or as a benchmark for evaluating project returns.

Understanding the Discount Rate Formula

The discount rate calculator uses two interconnected formulas: CAPM for the cost of equity and the WACC formula to blend equity and debt costs. Together, they produce the discount rate used in virtually all professional valuation work.

Where each variable represents:

• Re = Cost of equity (required return on equity)
• Rf = Risk-free rate (typically 10-year Treasury yield)
• β (Beta) = Systematic risk of the company relative to the market
• ERP = Equity Risk Premium (expected market return minus risk-free rate)
• E/V = Equity weight in the capital structure (equity / total capital)
• D/V = Debt weight in the capital structure (debt / total capital)
• Rd = Pre-tax cost of debt
• Tc = Corporate tax rate

Step-by-Step Calculation Example

Calculate the WACC for a mid-cap technology company:

1. CAPM inputs: Risk-free rate = 4.0%, Equity risk premium = 5.5%, Beta = 1.2
2. Cost of equity: Re = 4.0% + 1.2 × 5.5% = 4.0% + 6.6% = 10.6%
3. Debt inputs: Pre-tax cost of debt = 5.0%, Tax rate = 21%
4. After-tax cost of debt: 5.0% × (1 − 0.21) = 3.95%
5. Capital structure: 70% equity, 30% debt
6. WACC: (0.70 × 10.6%) + (0.30 × 3.95%) = 7.42% + 1.185% = 8.605%

The company's WACC of approximately 8.6% means it should only undertake projects expected to return more than 8.6%. This is the discount rate that would be used in a DCF valuation of this company, discounting all projected future free cash flows back to present value.

Impact of Capital Structure on WACC

Because debt is cheaper than equity (due to the tax shield and lower risk for lenders), increasing the debt proportion initially lowers WACC. However, beyond a certain point, additional debt increases both the cost of debt (higher default risk) and the cost of equity (higher financial risk to shareholders), causing WACC to rise. The optimal capital structure minimizes WACC. In practice, most large U.S. companies operate with 20-40% debt, which balances the tax benefit against financial risk.

Practical Discount Rate Examples

These scenarios show how discount rate calculations drive real investment and valuation decisions across different contexts.

Startup Valuation Due Diligence

Olivia is a venture capitalist evaluating a Series B investment in a software startup. The startup has no debt, so the discount rate is simply the cost of equity. Using CAPM with Rf = 4.0%, beta = 1.8 (high for a growth-stage company), and ERP = 5.5%, the cost of equity is 4.0% + 1.8 × 5.5% = 13.9%. However, Olivia adds a size premium of 3% (small companies carry additional risk not captured by beta) and an illiquidity premium of 2% (private companies cannot be easily sold), arriving at a total discount rate of 18.9%. At this rate, the startup's projected free cash flows of $5 million in year 5 have a present value of only $2.12 million. This high discount rate reflects the substantial risk of early-stage investing and ensures Olivia pays a fair price relative to the risk she is taking.

Corporate Capital Budgeting

James is CFO of a mid-size manufacturing company evaluating a $10 million factory expansion. The company's WACC is 9.2% based on Re = 11.5% (Rf = 4%, beta = 1.36, ERP = 5.5%), after-tax Rd = 4.1% (5.2% pre-tax, 21% tax rate), with a capital structure of 65% equity and 35% debt. The expansion project is expected to generate $2.2 million in annual free cash flow for 8 years. Using 9.2% as the discount rate, the NPV of the project is $2.2M × [1 − (1.092)^−8] / 0.092 = $12.17M, minus the $10M investment = $2.17M positive NPV. Since NPV is positive, the project exceeds the hurdle rate and creates value for shareholders. James approves the project because the expected return surpasses the company's cost of capital.

Public Company DCF Valuation

Natalie is an equity analyst building a DCF model for a large-cap consumer goods company. She calculates WACC using Rf = 4.0%, beta = 0.75 (defensive sector), ERP = 5.5%, giving Re = 8.125%. With pre-tax Rd = 4.0% (investment-grade issuer), tax rate = 23% (effective rate including state), and capital structure of 75% equity / 25% debt, the WACC is (0.75 × 8.125%) + (0.25 × 4.0% × 0.77) = 6.094% + 0.77% = 6.864%. She uses this 6.86% WACC to discount 10 years of projected free cash flows plus a terminal value calculated using a 2.5% perpetual growth rate. The terminal value formula is: FCF Year 11 / (WACC − Growth Rate) = $4.5B / (0.0686 − 0.025) = $103.2B. This demonstrates how sensitive the valuation is to the discount rate: at 7.86% WACC, the terminal value would be only $85.0B, a 17.6% decrease.

Discount Rate Tips and Complete Guide

Getting the discount rate right is arguably the most important step in any valuation or capital budgeting analysis. These strategies help you arrive at a defensible and accurate discount rate.

Use Market Data for Inputs

The most defensible WACC uses market-based inputs rather than arbitrary assumptions. Get the current risk-free rate from Treasury.gov, use published betas from financial data providers, reference the equity risk premium from academic sources like Damodaran, and use the company's actual cost of debt from its bond yields or credit facility terms. For the capital structure, use market values (market capitalization for equity, book value for debt) rather than book values for both. Market-weighted WACC better reflects the actual cost of capital because stock prices change while book equity does not.

Always Run Sensitivity Analysis

Because the discount rate significantly impacts valuation, never present a single WACC without sensitivity analysis. Create a table showing valuation at WACC minus 1%, base WACC, and WACC plus 1% at minimum. Better yet, create a two-dimensional sensitivity table varying both the discount rate and the terminal growth rate, the two inputs with the most impact on DCF valuation. This gives decision-makers a range of fair values rather than a false sense of precision from a single number.

Adjust for Project-Specific Risk

The company-level WACC is appropriate when the project under consideration has similar risk to the company's existing operations. For projects with meaningfully different risk, adjust the discount rate. An oil company evaluating a renewable energy project should not use its oil-focused WACC; it should use a discount rate reflecting renewable energy risk. One approach is to use the WACC of a pure-play company in the project's industry. Another is to add a project-specific risk premium to the company WACC, though this is more subjective.

Understand the Circularity Problem

WACC depends on the capital structure, which uses the market value of equity. But if you are using WACC to value the company (to determine equity value), you face a circular reference: you need the equity value to calculate WACC, but you need WACC to calculate the equity value. In practice, analysts resolve this by using an iterative approach (calculating WACC, valuing the company, recalculating WACC with the new equity value, repeating until convergence) or by targeting a capital structure based on industry averages or management's stated policy rather than the current market capitalization.

Common Mistakes to Avoid

• Using book value instead of market value for weights. The capital structure weights in WACC should reflect market values, not book values. A company with $1 billion in book equity but $5 billion in market cap has much more equity in its capital structure than the book suggests. Using book values can significantly misstate WACC.
• Forgetting the tax shield on debt. Interest on debt is tax-deductible, which makes the after-tax cost of debt lower than the pre-tax cost. Forgetting to multiply by (1 - Tax Rate) overstates the cost of debt and inflates WACC. At a 21% tax rate, this error alone can add 0.3-0.5% to the discount rate.
• Applying a U.S. risk-free rate to international analysis. Each country has its own risk-free rate reflecting its sovereign creditworthiness and monetary policy. Using the U.S. Treasury rate for a company in Brazil ignores Brazil's higher sovereign risk and inflation expectations.
• Using an outdated beta. Betas change over time as company risk profiles evolve. A technology company that was a volatile growth stock five years ago may now be a mature, stable business with a lower beta. Use the most recent available beta and consider using a 2-year beta rather than 5-year for companies that have undergone significant changes.
• Ignoring company size and illiquidity premiums. CAPM-derived cost of equity works well for large-cap public companies but understates the required return for small-caps, micro-caps, and private companies. Add a size premium (1-5% depending on market cap) and, for private companies, an illiquidity premium (2-4%) to arrive at a realistic discount rate.