Chapter 23, Problem 9P

Summary Introduction

Weighted Average Cost of Capital (WACC):

The weighted average cost of capital is the rate that a firm is expected to pay on average to all of its shareholders to finance its assets. WACC is the firm’s cost of capital and is dictated by the external market of the firm. It represents the minimum return that a firm ought to earn on an existing asset base in order to satisfy its creditors, owners, and other providers of capital, or else they would invested somewhere else.

Market-value based weights are used in the calculation of Weighted Average Cost of Capital. Book value shows the historical costs of a firm while market values are forward-looking and are based on what the assets of a firm are anticipated to yield in the future. Investors measure the performance of the firm on the basis of the market value of its assets, instead of the book value.

International integrated market:

An international market can be referred to as an activity of buying or selling goods and services across all the countries of the world. When an investor has the liberty to exchange any amount of any currency at the spot or forward rates and also has the authority to purchase or sell any security in any amount in any country at its current market prices such an international capital market is an integrated market.

To determine:

The euro cost of capital for a project with free cash flows that are uncorrelated with spot exchange rates.