Question

1. Why is the WACC used in capital budgeting?

Answer 1

WACC is weightage average cost of capital. While discounting the cash inflow from a project WACC is used as a discounting factor, or minimum rate of return.

If the project return is more than the WACC then project will be accepted else rejected.

Companies finance projects with debt and equity, these finance methods have some cost, the total cost of finance is called WACC, while evaluating a project if you select a project which has return less than WACC then it will result in losses, because it will not generate enough revenue to cover the costs.

That is the reason WACC is used in capital budgeting.

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Hope this answer your query.

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