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Factors That Affect The Wacc

The document discusses factors that affect the weighted average cost of capital (WACC). It identifies factors outside of a firm's control, such as interest rates, stock prices, and tax rates, and how these influence the cost of debt and equity. It also outlines factors a firm can control, like capital structure, dividend payout policy, and capital budgeting decisions, and how these impact the WACC. The document emphasizes that the cost of capital should be adjusted for project-specific risk levels to accurately assess whether a project's expected returns exceed its hurdle rate.

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Claire
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4K views15 pages

Factors That Affect The Wacc

The document discusses factors that affect the weighted average cost of capital (WACC). It identifies factors outside of a firm's control, such as interest rates, stock prices, and tax rates, and how these influence the cost of debt and equity. It also outlines factors a firm can control, like capital structure, dividend payout policy, and capital budgeting decisions, and how these impact the WACC. The document emphasizes that the cost of capital should be adjusted for project-specific risk levels to accurately assess whether a project's expected returns exceed its hurdle rate.

Uploaded by

Claire
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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FACTORS

THAT
AFFECT THE

WACC

Factors the Firm Cannot


Control

Interest rates in the


economy
General level of stock
prices
Tax rates

Interest
rates
Ex:

Interest
rates

Cost of
debt

Cost of
capital

If interest in the economy rise, the


cost of debt increases

General level of stock prices


Ex:

Stock
price

Cost of
equity

Cost of
capital

If stock prices in general decline,


its cost of equity will rise.

Tax rates
Ex:

Tax rates

Cost of
debt

Cost of
capital

When tax rates increases, cost


of debt decreases

FACTORS THE FIRM CAN CONTROL

By changing its capital


structure
By changing its dividend
payout ratio
By altering its capital
budgeting decision

Capital Structure Policy

As more debt is
issued, the cost
of debt
increases, and as
more equity is
issued, the cost

Dividend Policy

As the payout
ratio of the
company
increases the
breakpoint
between lowercost internally
generated

Capital Budgeting Policy

The company is
making investments
with similar degrees
of risk.
If a company
changes its
investment policy
relative to its risk,

ADJUSTING THE COST OF CAPITAL


FOR RISK

Projects should be accepted


if and only if their
estimated returns exceed
their costs of capital.

Cost of capital is a HURDLE RATE

A projects
expected rate
of return must
jump the
hurdle for it
to be accepted.

Therefore, each projects hurdle rate


should reflect the risk of the project,
not the risk associated with the firms
average project as reflected in the
composite WACC.

But if a project has an


especially high or low risk, the
WACC will be adjusted to
account for the risk differential.

L
H
0.50(7%) + 0.50(13%)
= 10%

Firm
A

SOME OTHER PROBLEMS WITH


COST OF CAPITAL ESTIMATES

Depreciationgenerated funds
Privately owned firms
Measurement
problems
Costs of capital for

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