weighted average cost of capital

• Weighted Average Cost of Capital

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Stern Review on the Economics of Climate Change - Market rates

1 The higher rates preferred by Stern's critics are closer to the weighted average cost of capital for private

investment; see the extensive review by Frederick et al


Corporate finance - Capitalization structure

1 Cohen, Citigroup (See Balance sheet, Weighted average cost of capital|

WACC.) Financing a project through debt results in a liability

(accounting)|liability or obligation that must be serviced, thus entailing cash flow implications independent of the project's degree of success


Corporate finance - Investment and project valuation

1 Aswath Damodaran: [ http://people.stern.nyu.edu/adamodar/pdfil

es/acf3E/presentations/hurdlerate.pdf Estimating Hurdle Rates] Managers use models such as the capital asset pricing

model|CAPM or the arbitrage pricing theory|APT to estimate a discount rate appropriate

for a particular project, and use the weighted average cost of capital (WACC) to

reflect the financing mix selected


Financial model - Accounting

1 *Cost of capital (i.e. Weighted average cost

of capital|WACC) calculations


Business valuation - Weighted average cost of capital (WACC)

1 The weighted average cost of capital is an approach to determining a discount rate. The

weighted average cost of capital|WACC method determines the subject company’s

actual cost of capital by calculating the weighted average of the company’s interest

(finance)|cost of debt and cost of stock|equity. The weighted average cost of capital|

WACC must be applied to the subject company’s net cash flow to total invested

capital.



1 One of the problems with this method is that the valuator may

elect to calculate weighted average cost of capital|WACC according to the

subject company’s existing capital structure, the average industry capital structure, or the optimal capital structure. Such discretion

detracts from the objectivity of this approach, in the minds of some

critics.https://store.theartofservice.com/the-weighted-average-cost-of-capital-toolkit.html


1 Indeed, since the weighted average cost of capital|WACC captures the

risk of the subject business itself, the existing or contemplated capital structures, rather than industry averages, are the appropriate choices for business valuation.


Modigliani-Miller theorem - Proposition II

1 A higher debt-to-equity ratio leads to a higher required return on equity, because of the higher risk involved

for equity-holders in a company with debt. The formula is derived from the theory of weighted average cost of

capital (WACC).


Modigliani-Miller theorem - Proposition II

1 The formula, however, has implications for the difference with

the Weighted average cost of capital|WACC


Working capital management - Capitalization structure

1 Cohen, Citigroup (See Balance sheet, Weighted average cost of capital|

WACC.) Financing a project through debt results in a liability

(accounting)|liability or obligation that must be serviced, thus entailing cash flow implications independent of the project's degree of success


Working capital management - Investment and project valuation

1 Aswath Damodaran: [http://people.stern.nyu.edu/adamodar/pdfil

es/acf3E/presentations/hurdlerate.pdf Estimating Hurdle Rates] Managers use models such as the capital asset pricing

model|CAPM or the arbitrage pricing theory|APT to estimate a discount rate appropriate

for a particular project, and use the weighted average cost of capital (WACC) to

reflect the financing mix selected


Capital budgeting - Capital Budgeting Definition

1 Managers may use models such as the capital asset pricing model|CAPM or the arbitrage pricing theory|APT to estimate a discount rate appropriate for each particular project, and use

the weighted average cost of capital (WACC) to reflect the financing mix

selected


Real options valuation - Applicability of standard techniques

1 Under this “standard” NPV approach, future expected cash flows are present

valued under the Mathematical_finance#Risk_and_portfolio

_management:_the_P_world|empirical probability measure at a discount rate that reflects the embedded risk in the

project; see Capital asset pricing model|CAPM, Arbitrage pricing theory|APT,

Weighted average cost of capital|WACC


Financial statement analysis

1 Unlike other ratios, return on capital has a theoretical benchmark, the cost of capital -

also called the required return on capital. For example, the return on equity, ROE, could be compared with the required return on equity, kE, as estimated, for example, by the capital

asset pricing model. If ROE WACC, where WACC is the weighted average cost of capital), then the firm is economically profitable at any given time over the period of ratio analysis.

The firm creates values for its owners.


Discounted cash flow - Discount rate

1 The discount rate used is generally the appropriate weighted average

cost of capital (WACC), that reflects the risk of the cashflows. The

discount rate reflects two things:


Weighted average cost of capital

1 The 'weighted average cost of capital (WACC)' is the rate that a company is expected to pay on

average to all its security holders to finance its assets.


Working capital management - Capitalization structure

1 Cohen, Citigroup (See Balance sheet, Weighted average cost of capital|WACC) but must also take other

factors into account (see trade-off theory below)


Residual income valuation - Comparison with other valuation methods

1 As can be seen, the residual income valuation formula is similar to the

dividend discount model (DDM) (and to other discounted cash flow (DCF)

valuation models), substituting future residual earnings for dividend (or free

cash) payments (and the cost of equity for the weighted average cost

of capital).


Tax shield - Case A

1 The concept was originally added to the methodology proposed by Merton

Miller for the calculation of the weighted average cost of capital of a

corporation.


Adjusted present value

1 Technically, an APV valuation model looks similar to a standard Discounted cash flow|DCF model. However, instead of weighted average cost of capital|WACC, cash flows

would be discounted at the unlevered cost of equity, and tax shields at either the cost

of debt (Myers) or following later academics also with the unlevered cost of

equity.http://www.iese.edu/research/pdfs/DI-0488-E.pdf


Cost of capital - Expected return

1 K_ = \frac Dividend_ Payment/ShareMain|Weighted

average cost of capitalMain|Capital structureMain|Modigliani-Miller

theorem


Modified Internal Rate of Return - Problems with the IRR

1 Generally for comparing projects more fairly, the weighted average cost of capital should be used for

reinvesting the interim cash flows.


Trade-off theory of capital structure - Evidence

1 It is shown that suggestion of risky debt financing (and growing credit

rate near the bankruptcy) in opposite to waiting result does not lead to

growing of weighted average cost of capital, WACC, which still decreases

with leverage


Payback period - Purpose

1 Whilst the time value of money can be rectified by applying a weighted

average cost of capital discount, it is generally agreed that this tool for

investment decisions should not be used in isolation


Cash surplus value added

1 'Cash value added' ('CVA') is a measure of business Profit (accounting)|profitability defined as the EBITDAhttp://books.google.co.uk/books?id=zTQiuDMZkpICpg=PA9#v=onepageqf=false

after tax generated by the business less its required return. The required return is an

Annuity (finance theory)|annuity based on the purchase price of the assets in use in the

business, inflated to today's value of money, the weighted average cost of capital (WACC) and

the economic life of the assets.


CROCI - Uses

1 * The (CROCI – Weighted average cost of capital|WACC) spread is a key

measure of shareholder value creation and competitive advantage. If the spread is positive, a company

creates value and destructs it otherwise.


Public-private partnerships - Controversy

1 the weighted average cost of capital (WACC)


Weighted average return on assets

1 In theory, the WARA should generate the same cost of capital as the

Weighted average cost of capital, or WACC


Cost of debt - Expected return

1 K_ = \frac(1+Growth)Price_ MarketMain|Weighted average cost

of capitalMain|Capital structureMain|Modigliani-Miller theorem


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