Question

Answer the following general questions regarding WACC

a. Name some factors that are generally beyond the firm’s control but still affect its cost of capital.

b. What three policies under the firm’s control affect its cost of capital?

c. Explain how a change in interest rates in the economy would be expected to affect each component of the weighted average cost of capital.

d. What four mistakes are commonly made when estimating the WACC?

Answer 1

A. Some factors beyond the firm's control are market risks like inflation rate, political risks like political instability, environmental regulation risk etc.

B. Three policies are dividend policies, investment policies, and capital structure policy which are under the firm's control and which affect the cost of capital.

C . A change in the interest rate iwould affect the debt as debt has a a stream of interest payment attached to it and it will also impact the equity shareholders caused by impacting the tax structure.

D.Four mistakes while determining the weighted average cost of capital are as follows-

1. Use of the book weights to determine the capital structure.

2. Using the coupon rate on the firm existing debt as the cost of debt.

3. Subtracting the current long term bond rate from historical average.

4. Fundings from non investors are also considered.