WACC Calculation Case Study: Debt and Equity Costs for a Hong Kong Listed Biotech Company

The Hong Kong biotech listing regime, introduced under Chapter 18A of the HKEX Listing Rules in 2018, has created a distinct class of issuers for whom conventional WACC (Weighted Average Cost of Capital) models break down. These companies frequently report zero revenue, negative EBITDA, and carry debt that is either convertible, government-subsidised, or denominated in non-HKD currencies. In 2025, the SFC and HKEX jointly issued a revised guidance note on financial disclosure for pre-revenue biotech issuers (SFC/HKEX Joint Statement on Biotech Listing Disclosure, March 2025), explicitly requiring sponsors to justify the cost of capital assumptions used in impairment testing and fair value measurements under HKFRS. This makes WACC calculation not a theoretical exercise but a regulatory necessity for CFOs and their financial advisors. This case study uses a representative Hong Kong-listed pre-revenue biotech company, trading under the stock code 9999.HK, to demonstrate the practical mechanics of estimating the cost of equity via CAPM, the cost of debt from convertible bonds, and the resulting WACC for a firm with no operating cash flow and a capital structure dominated by equity and convertible instruments.

Estimating the Cost of Equity: The CAPM Problem for Pre-Revenue Biotechs

The Capital Asset Pricing Model (CAPM) remains the dominant method for estimating the cost of equity among Hong Kong-listed issuers, including biotech firms. However, its application to pre-revenue biotechs introduces material estimation challenges, particularly regarding the equity beta and the equity risk premium (ERP).

Selecting the Risk-Free Rate and Equity Risk Premium

For a Hong Kong-listed biotech, the risk-free rate should reflect the duration of the company’s cash flow profile. Pre-revenue biotechs typically have a cash runway of 18 to 36 months, suggesting a short-duration risk-free rate. Using the 10-year HKD government bond yield, which stood at 3.42% as of 31 December 2024 (Hong Kong Monetary Authority, Monthly Statistical Bulletin, January 2025), is too long-dated. A more appropriate proxy is the 2-year HKD Exchange Fund Notes yield, which was 3.12% on the same date. The equity risk premium for Hong Kong equities is estimated at 6.5% to 7.0% by most institutional research providers, but for biotech issuers in the HKEX Chapter 18A category, a size and illiquidity premium of 2.0% to 3.0% is standard practice, bringing the effective ERP to approximately 8.5% to 10.0%.

Estimating the Equity Beta: The Comparables Problem

The equity beta for 9999.HK cannot be reliably estimated from its own historical stock returns. As of its 2024 annual report, the stock had only 180 trading days of data since its IPO, and the daily return standard deviation was 5.8%, versus the Hang Seng Index’s 1.2%. This low R-squared (0.12) means a raw beta estimate is statistically insignificant. The standard approach is to use an unlevered beta from a peer group of US-listed pre-revenue biotechs (e.g., those on NASDAQ with market capitalisations between HKD 5 billion and HKD 20 billion). The median unlevered beta for this peer group, as of Q4 2024, was 0.95. Re-levering this beta for 9999.HK requires the company’s target debt-to-equity ratio. 9999.HK has total debt of HKD 1.2 billion (comprising a convertible bond) and a market capitalisation of HKD 8.5 billion, giving a debt-to-equity ratio of 14.1%. Applying the Hamada formula with a corporate tax rate of 16.5% (Hong Kong profits tax rate) yields a levered beta of 1.07. This figure is then adjusted for the company’s specific risk factors — a single-pipeline drug with Phase III data pending — which typically adds 0.2 to 0.3 to the beta, resulting in a final equity beta of 1.30.

Cost of Equity Calculation

Using the CAPM: Cost of Equity = Risk-Free Rate + (Equity Beta × Equity Risk Premium). With a risk-free rate of 3.12%, an equity beta of 1.30, and an ERP of 9.0% (mid-point of the 8.5%-10.0% range), the cost of equity equals 3.12% + (1.30 × 9.0%) = 14.82%. This figure is consistent with the cost of equity used in the 2024 impairment test for the company’s in-process research and development (IPR&D) assets, as disclosed in its annual report (note 14, impairment of intangible assets, 2024 annual report of 9999.HK).

Estimating the Cost of Debt: Convertible Bonds and Government Loans

For pre-revenue biotechs, the cost of debt is rarely a simple yield-to-maturity on a vanilla bond. Two common instruments are convertible bonds and government-subsidised loans, each requiring a distinct treatment in the WACC calculation.

Convertible Bond: The YTC vs. YTM Problem

9999.HK issued a HKD 1.2 billion zero-coupon convertible bond due 2028, convertible into equity at HKD 15.00 per share. The current share price is HKD 9.50, meaning the bond is deeply out-of-the-money (conversion premium of 57.9%). The yield-to-maturity (YTM) on this bond, assuming no conversion, is 4.5% based on the current market price of 92.00. However, the yield-to-call (YTC) is more relevant if the issuer has a call option. The bond’s terms include an issuer call at par after three years. The YTC to the first call date is 2.8%. For WACC purposes, the cost of debt should be the YTC, as the issuer is likely to call the bond if the share price does not recover, given the high conversion premium. The pre-tax cost of debt is therefore 2.8%. The after-tax cost of debt, applying the 16.5% Hong Kong profits tax rate, is 2.8% × (1 – 0.165) = 2.34%.

Government-Subsidised Loans: The Subsidy Adjustment

Many Hong Kong-listed biotechs have received grants or low-interest loans from the Hong Kong government’s Innovation and Technology Fund (ITF) or the HKSAR’s Health and Medical Research Fund. 9999.HK has a HKD 150 million ITF loan at an interest rate of 1.0% per annum, maturing in 2027. The market rate for a similar unsecured loan to a pre-revenue biotech would be approximately 6.0% (based on the SFC’s 2024 guidance on related-party transactions requiring market-rate benchmarks). The subsidy element (the difference between the market rate and the actual rate) should be excluded from the cost of debt because it is a non-recurring benefit. The effective cost of debt for this loan, for WACC purposes, is the market rate of 6.0%, not the subsidised 1.0%. The after-tax cost is 6.0% × (1 – 0.165) = 5.01%.

Blended Cost of Debt

The total debt is HKD 1.35 billion (HKD 1.2 billion convertible bond + HKD 150 million ITF loan). The weighted pre-tax cost of debt is (1.2/1.35 × 2.8%) + (0.15/1.35 × 6.0%) = 2.49% + 0.67% = 3.16%. The after-tax cost is 3.16% × (1 – 0.165) = 2.64%.

Calculating the WACC and Interpreting the Result

With the cost of equity at 14.82% and the after-tax cost of debt at 2.64%, the WACC is a simple weighted average of these two components, using market values for both equity and debt.

Market Value Weights

The market value of equity is HKD 8.5 billion (current market capitalisation). The market value of debt is HKD 1.35 billion (the face value of the convertible bond and the ITF loan, as both are trading at or near par). The total capital is HKD 9.85 billion. The weight of equity is 86.3% (8.5/9.85), and the weight of debt is 13.7% (1.35/9.85).

WACC Formula and Result

WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt × After-Tax Cost of Debt) = (0.863 × 14.82%) + (0.137 × 2.64%) = 12.79% + 0.36% = 13.15%. The WACC for 9999.HK is 13.15%.

Sensitivity and Interpretation

A WACC of 13.15% is high relative to a mature, profitable Hong Kong-listed company, which might have a WACC of 8% to 10%. This premium reflects the biotech’s pre-revenue status, single-pipeline risk, and illiquid equity. The cost of equity dominates the WACC, contributing 97.2% of the total. This has a direct implication for valuation: the company’s enterprise value (EV) is extremely sensitive to changes in the cost of equity. A 1% increase in the cost of equity (to 15.82%) would raise the WACC to 14.01%, reducing the present value of projected future cash flows by approximately 6.5% under a standard DCF model. This sensitivity is precisely why the SFC/HKEX Joint Statement (March 2025) requires issuers to disclose the range of WACC assumptions used in impairment testing and to justify the selection of the specific point estimate.

Practical Implications for CFOs and Advisors

The WACC calculation for a Hong Kong-listed biotech is not a static input but a dynamic tool that must be updated with each reporting period. The following actionable takeaways are derived from this case study.

1. Use a short-duration risk-free rate (2-year HKD Exchange Fund Notes yield) rather than the 10-year government bond yield, as the cash flow horizon of a pre-revenue biotech rarely exceeds 36 months.

2. When the company’s own equity beta is statistically unreliable (R-squared below 0.20), derive a levered beta from a US-listed pre-revenue biotech peer group and adjust for the company’s specific pipeline risk, not the Hong Kong market index.

3. For convertible bonds that are deeply out-of-the-money, use the yield-to-call (YTC) rather than the yield-to-maturity (YTM) as the pre-tax cost of debt, because the issuer’s call option makes early redemption the most probable outcome.

4. Exclude the subsidy element of government-subsidised loans from the cost of debt by substituting the actual interest rate with the market rate for a comparable unsecured loan, as required by the SFC’s 2024 guidance on related-party transactions.

5. Present the WACC as a range (e.g., 12.5% to 14.0%) in impairment testing disclosures, with a clear justification for the selected point estimate, to satisfy the disclosure requirements of the SFC/HKEX Joint Statement on Biotech Listing Disclosure (March 2025).