B3: Weight Average Cost of Capital

Question 1

What purpose does the WACC serve

Answer 1

it is a major link between long term investment decisions associated with a corporation’s capital structure and the wealth of a corporation’s owners

Question 2

What is the optimal capital structure

Answer 2

mix of financing instruments that produces the lowest WACC

Question 3

What is the WACC

Answer 3

it is the average cost of debt and equity financing associated with a firm’s existing assets and operations

Question 4

What are the cost of capital components

Answer 4

The cost of borrowing (interest rates on debt) and the cost of equity (return required by investors in exchange for assumed risk)

Question 5

What is the difference between dividends and debt

Answer 5

Dividends are not tax deductible and debt carries interest which is tax deductible

Question 6

Why are after tax considerations irrelevant with equity securities

Answer 6

because dividends are not tax deductible

Question 7

What are the three methods of computing the cost of retained earnings

Answer 7

CAPM, DCF, and BYRP