Saudi valuations often go wrong for one simple reason. Analysts import a textbook WACC and apply it to SAR cash flows without adjusting for local mechanics.
This post lays out a practical, audit-friendly WACC workflow for Saudi companies. The goal is not a single perfect number - it’s a WACC that is internally consistent, explainable to a CFO, and easy to sensitize.
The Core Definition
Weighted Average Cost of Capital is the blended required return demanded by all capital providers:
WACC = (w_e × K_e) + (w_d × K_d)
Where:
- w_e, w_d are market value weights of equity and debt
- K_e is cost of equity
- K_d is cost of debt - after-tax only when a genuine tax shield exists
Step-by-Step WACC Workflow for Saudi Companies
Step A - Pick the valuation currency first
If your cash flows are in SAR, every WACC input must be SAR-consistent:
- Risk-free rate must be SAR-based
- Country risk adjustments must not be double-counted
- Inflation and growth assumptions should match the currency
If you are valuing in USD, that is also defensible - but then cash flows, discount rate, and terminal growth must all be USD-consistent. Do not mix the two.
Step B - Estimate the SAR risk-free rate
Two defensible approaches:
- Direct SAR government yield - use a long-tenor SAR government bond yield when a reliable, liquid benchmark is available.
- Peg-consistent build-up - start with a USD risk-free rate and add a Saudi sovereign spread proxy:
R_f(SAR) = R_f(USD) + CDS(KSA)
Use the same tenor for both components. Label inputs as illustrative if you are not using a live market feed.
Step C - Build cost of equity using CAPM, then sanity-check it
Baseline CAPM:
K_e = R_f + (β × ERP)
Document clearly:
- Risk-free rate source and tenor
- Beta method (regression beta, adjusted beta, or bottom-up beta)
- ERP construction - global base, plus any country risk component if used
Useful cross-checks:
- Compare K_e to a dividend yield plus a conservative long-run growth rate (a pricing check, not a replacement for CAPM)
- Compare K_e to a reasonable range for the sector and company size, and explain any drivers of divergence
Step D - Estimate cost of debt from observable pricing or a synthetic rating
Two approaches:
- Observable pricing - use latest facility pricing, sukuk yield, or spreads over SAIBOR
- Synthetic rating - map financial ratios to a rating band, then apply a spread range
Keep K_d as the current marginal borrowing rate, not the historical average cost.
Step E - Handle Zakat vs tax consistently
This is where Saudi WACC models most often break.
If the company is primarily a Zakat payer, interest expense typically does not create the same corporate income tax shield that the textbook formula assumes. Applying K_d × (1 − t) in that case understates WACC.
Practical defaults:
- Income tax payer → use after-tax cost of debt: K_d × (1 − t)
- Zakat payer → use pre-tax cost of debt as a conservative default, unless a specific tax shield mechanism is clearly documented
- Mixed structure → apply a weighted approach consistent with the entity’s actual tax position
Step F - Use market value weights, and document all approximations
- w_e = E / (D + E), where E is market cap (or a defensible private valuation proxy)
- w_d = D / (D + E), where D is the market value of interest-bearing debt (book value is often a reasonable approximation when close to par)
Worked Example (Illustrative Numbers Only)
| Input | Value |
|---|---|
| SAR risk-free rate | 5.5% |
| Equity risk premium | 6.0% |
| Beta | 1.1 |
| Marginal cost of debt | 7.0% |
| Equity (market cap) | SAR 1,000M |
| Debt (book approx.) | SAR 500M |
Cost of equity: K_e = 5.5% + (1.1 × 6.0%) = 12.1%
Weights: w_e = 1,000 / 1,500 = 66.7% | w_d = 500 / 1,500 = 33.3%
WACC - Zakat payer (no conventional tax shield): WACC = (0.667 × 12.1%) + (0.333 × 7.0%) = 10.4%
WACC - income tax payer at t = 20%: WACC = (0.667 × 12.1%) + (0.333 × 7.0% × 0.80) = 9.9%
The point is not the decimal places. The point is to show clearly why the tax treatment assumption matters and to make it explicit in every model.
Integrity Checklist Before You Publish a Number
- Currency consistency - SAR cash flows and SAR risk-free rate are matched
- No double counting - if country risk is in ERP, it should not also appear elsewhere
- Debt pricing realism - K_d reflects current marginal cost, not last year’s average
- Tax treatment stated plainly - one sentence in the assumption box is sufficient
- Sensitivity table included - WACC ± 0.5% and ± 1.0%, with valuation impact shown
This article is for educational purposes only. It explains valuation concepts and modeling choices. It is not investment advice, a recommendation, or a financial promotion. Examples use illustrative inputs. Verify all data using primary sources and consult an appropriately licensed professional before making financial decisions.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute. This content is not endorsed by or affiliated with CFA Institute.
Abdul Gaffar Mohammed, CFA
Treasury & Investment Professional