Question

Explain the impact of changes of investors’ required rate of return on WACC and a project’s NPV.

Answer 1

When investors required return changes let's say increases then cost of financing for the firm will increase and hence WACC will increase because WACC is the weighted average of cost of each source of capital

Similarly when required return decreases then WACC will decrease.There are basically three sources of capital namely debt ,equity and preferred stock therefore investor here means any of the above investors

Now ,When required return will increase then WACC will increase as discussed above and then NPV will decrease because WACC is the discount rate for discounting of cash flows and higher the rate ,lower will be the discounted value and hence lower NPV .

Therefore we can say investors required return is directly proportional to WACC and inversely proportional to NPV.