Question

WACC is the rate used to discount future cash flows, it can make a big difference as to which projects get accepted.

How do companies try to keep the WACC low?

Answer 1

WACC is the weighted average of the weights and the cost of capital of all the individual sources of finance, namely equity, preference capital and debt. The higher the WACC , the greater is the risk in the organisation. The cash flows generated in a project are discounted at the WACC, to find the present value of the cash flows. The higher the WACC, the lower is the value fo the project, so yes the WACC makes a big difference on which project is accepted.

Company can reduce the WACC, by lowering debt, lowering the cost of equity capital and restructuring the capital structure of the company. When the cost of equity is high, the company can substitute equity with debt as debt is cheaper and the cost of debt is lower after taxation.

Company can lower the cost of equity, by offering stocks which have lower risk and they do not have to offer a very high risk premium.