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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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Suppose a firm estimates its WACC to be 10%. Should the WACC be used to evaluate all of its potential projects, even if they vary in risk? If not, what might be “reasonable” costs of capital for average-, high-, and low-risk projects?

Summary Introduction

To identify: The WACC should be used or not to evaluate all its potential project even if they vary in risk and if WACC is not used the reasonable costs of capital for average, high, and low-risk projects.

Introduction:

Weighted Average Cost of Capital:

It is the weighted average cost of capital of all the sources through which the firm finances its capital. It is  the rate that a company will pay to all for raising finance. It can be termed as firm’s cost of capital. The company raises money through various sources such as common stock, preference share debt the WACC is calculated taking the relative weight of each item of capital structure.

Explanation
  • The WACC should not be used to evaluate all the potential projects if the project vary in risk.
  • In case of the average, high and-risk project, the WACC should be adjusted.
  • The WACC will change as per the market fluctuations and funding strategy...

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