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Conduct a comparative analysis of the capital budgeting process for new projects versus replacement decisions. The...

Conduct a comparative analysis of the capital budgeting process for new projects versus replacement decisions. The objective is to maximize shareholder wealth.

Question: Explain why the weighted average cost of capital (WACC) is used in capital budgeting.

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Answer #1

Weighted average cost of capital is used in the capital budgeting process because it is the proper reflection of the true cost of capital of company because it has been weighted after cost of equity and cost of debt which have been used in different proportion for obtaining of the rate of return for the company.

Weighted average cost of capital has been calculated after assignment of weights to equity and debt and it has also assigned the interest tax advantage to debt capital so it is a proper reflection of the true cost of capital to the company and it is also risk weighted in some cases in order to have the better idea of the cost, the company is incurring in order to generate the rate of return, so it is to be considered while calculation of the cost of capital and capital budgeting process.

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