The discount rate used in a DCF valuation model – often the WACC – has an outsized impact on the value of the business! So, getting the discount rate or WACC right is important. A key ingredient of the WACC computation is the weight of debt. Students are often not sure what is included in debt as there are a number of ways companies can finance their capital needs including accounts payables, notes payables, off-balance sheet liabilities, collataralization, etc. We address this question “What kinds of liabilities are included in debt when computing the weight of debt (used in computing WACC)?” on this page.
Only interest-bearing liabilities are included in debt when computing the weight of debt. The reason is that you are estimating the cost of capital and so want to figure out the proportion of capital funded by debt. Since capital providers want a return on their capital proportionate to the risk taken, they will demand a fee (an interest) for their capital. Therefore, interest is considered the indicator of the liabilities to be included in debt.
Non-interest-bearing liabilities such as accounts payable is excluded because it is deemed to be capital provided in the ordinary course of business rather than a source of funding. The providers of this kind of credit are extending credit to further their business.