WACC, Terminal Value and the Enterprise-to-Equity Bridge

Building WACC, piece by piece

The weighted average cost of capital blends the return equity investors require with the after-tax cost of debt, weighted by how much of each the business actually uses.

• —Cost of equity (CAPM): risk-free rate 7.1% + beta 1.05 × equity risk premium 6.5% = 13.92%.
• —Post-tax cost of debt: 9.5% × (1 − 25.17% tax rate) = 7.11% — lower than the pre-tax rate because interest is deductible.
• —Weights, at market value: equity 88.6%, debt 11.4%.

Blended: (13.92% × 88.6%) + (7.11% × 11.4%) = WACC of 13.15%.

Terminal value: everything past the forecast

A three-year explicit forecast cannot capture a business’s whole future, so a terminal value stands in for everything beyond it:

TV = final-year FCFF × (1 + g) ÷ (WACC − g)

Final forecast year FCFF of ₹86.14 crore, grown at 4.5% terminal growth, gives a terminal FCFF of roughly ₹90.02 crore. Divided by (13.15% − 4.5%) = 8.65%, the undiscounted terminal value is about ₹1,040.96 crore.

Terminal growth below WACC is not a preference

If terminal growth equalled or exceeded WACC, the denominator would be zero or negative and the formula would return something infinite or nonsensical. This is a hard mathematical constraint of the perpetual-growth formula, not a modelling convention you can argue with.

A model worth trusting enforces the check and refuses to run when it is violated. 4.5% against a 13.15% WACC clears it comfortably.

Discounting to enterprise value

Discount each piece back at WACC. The three explicit years’ FCFF — ₹70.62, ₹77.98 and ₹86.14 crore — discounted at 13.15% sum to ₹182.79 crore. The terminal value of ₹1,040.96 crore, discounted back three years at the same rate, becomes ₹718.62 crore.

Enterprise value: ₹182.79 + ₹718.62 = ₹901.41 crore.

Note the proportions. Nearly 80% of this enterprise value sits in the terminal value — which is why the terminal growth assumption deserves far more scrutiny than it usually gets.

The bridge, and the mistake in it

Suppose someone moves from enterprise value to equity value by adding cash and stopping: ₹901.41 crore + ₹175.10 crore cash = ₹1,076.51 crore, over 10.00 crore shares = ₹107.65 per share.

That is wrong. It never subtracted the ₹130 crore of debt. The bridge in full is enterprise value − debt + cash = equity value.

Corrected: ₹901.41 − ₹130.00 + ₹175.10 = ₹946.51 crore, over 10.00 crore shares = ₹94.65 per share — meaningfully below the mistaken figure, by exactly the debt per share.

How to check the bridge independently

• —Confirm debt and cash enter with opposite signs — debt subtracted, cash added.
• —Sanity-check that equity value is always lower than enterprise value plus cash whenever the company carries any debt. If it isn’t, you have made exactly this mistake.

What a gap to market price does and doesn’t prove

The DCF here lands at ₹94.65 against a simulated market price of ₹100.97. Does that prove the market has overpriced the shares?

No. A ~6% gap sits well inside the range that ordinary estimation uncertainty in WACC, terminal growth or the forecast itself can produce. What it does mean is narrower and more useful: this specific, fully documented set of assumptions implies a value modestly below the current price. That is a real finding, properly qualified — and the next step is a sensitivity table showing how fast the conclusion moves when those assumptions change.

Common mistakes

• —Omitting debt from the enterprise-to-equity bridge.
• —Using the pre-tax cost of debt in WACC and ignoring the interest deduction.
• —Weighting the capital structure at book value when market values are available.
• —Setting terminal growth at or above WACC, or close enough that the result explodes.
• —Forgetting to grow the final year’s cash flow one more period before capitalising it.
• —Presenting one point estimate as the answer instead of a range with its sensitivities.