The blended cost of a company's capital, weighted by the proportion of debt and equity in its capital structure — used as the discount rate in DCF valuations.
Deeper Explanation
WACC is calculated as: (equity weight × cost of equity) + (debt weight × after-tax cost of debt). The cost of equity is unobservable and must be estimated — most practitioners use the CAPM model, which derives cost of equity from beta, creating a circular dependency on a metric Buffett considers flawed as a measure of risk. Buffett uses a simple rule: he discounts owner earnings at approximately the long-term US Treasury bond yield plus a risk premium, typically 8–10% for most businesses. Using a higher discount rate for all businesses (regardless of perceived risk) produces more conservative intrinsic value estimates — which is exactly the right bias for a value investor.
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