Two companies are exactly the same, but one has debt and one does not – which one will have the higher WACC?

The one without debt will generally have a higher WACC because debt is “less expensive” than equity. Why?

• Interest on debt is tax-deductible (hence the (1 – Tax Rate) multiplication in the WACC formula).

• Debt is senior to equity in a company’s capital structure – debt holders would be paid first in a liquidation or bankruptcy scenario.

• Intuitively, interest rates on debt are usually lower than the Cost of Equity numbers you see (usually over 10%). As a result, the Cost of Debt portion of WACC will contribute less to the total figure than the Cost of Equity portion will.

Theoretically if the company had a lot of debt, the Cost of Debt might increase and become greater than the Cost of Equity but that is extremely rare – the company without debt has a higher WACC in 99% of all cases.