finance lec 7 - weighted cost of capital

Question 1

WACC is also sed as

Answer 1

discount rate in investmenet appraisal

Question 2

WACC is based on

Answer 2

avg ke and kd

Question 3

WACC is wieghted to reflect

Answer 3

proprotions of equity and debt in capital structure

Question 4

weighting is usually based on the

Answer 4

mkt value of equity and debt

Question 5

if given market value and book value which one should you use

Answer 5

market valu

Question 6

WACC formula

Answer 6

Ke * (E/E+D) + Kd * (D/E+D)

E = mkt value of equity
D = mkt value of debt

Question 7

what is the WACC formula transalted into words

Answer 7

cost of equity x weighting of equity as a proportion of market value of total capital + cost of debt x weighting of debt as a proportion of total capital

Question 7

sometimes kd is

Answer 7

rd x(1-t)

return on debt * 1 - tax rate

Question 8

weights must always su to

Answer 8

1

Question 8

if given post tax cost of debt what do we ignore

Answer 8

pretaxd

Question 9

do exmaples from teh slide

Question 11

what are the practical problems with WACC

Answer 11

• if D and E not traded - means we dont have mkt val which we use to calc the cost of capital (problematic for shares in priv companies as they not traded- debt are bank loans which arent traded so no mkt value)
• May have unconventional types of debt e.g leasing nd OD - if we include them how do we value them
• difficult to predict dividend growht (e.g. ke eneeds cnstant growth rate)

Question 12

WACC as project disocunt rate

Question 13

WACC for company should only be used as a project discount rate if

Answer 13

business risk is teh same ie in same indstry

financial risk is the same i,e same capital structure

project is marginal to teh copmany

Question 14

if condition sof wacc arent met what do we do

Answer 14

estimate WACC for project based on risk profile

e.g look at WACC for similar copanies

Question 15

give example of good WACC project discount rate meeeting and bad WACC project disocunt rate

Answer 15

uber x shelll - no

uber x lyft - yah