Question

Maltese Falcone, Inc., has not checked its weighted average cost of capital for four years. Firm management claims that since Maltese has not had to raise capital for new projects in four years, they should not have to worry about their current weighted average cost of capital. They argue that they have essentially locked in their cost of capital. Critique management’s statements.

Answer 1

The management statement is a false statement.The assumption by Maltese Falcone that it does have to check weighted average cost of capital as it does not have to raise any capital.As we know that in liquid capital market firms investors have the opportunity to sell their investment in the market which means firms have to compete for the investment everyday.Investors of a firm aim for good return from their investment and if they do not the ample return they will sell off their investment which will lead to the fall in the prices of their stocks which will consequently rise the weighted average cost of capital of the company.So if firm simply assume it has simply locked its cost of capital will might rising its cost of capital by making such false assumptions.