Shareholders risk perception of the company''s activities, Financial Accounting

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The existing company WACC replicates the company's current gearing level and its existing Ke and Kd and the Ke in turn reflects the shareholders' risk perception of the company's existing activities.

Therefore the existing WACC is only suitable for project appraisal if

(i) The project has the similar business risk as the company's existing activities so that overall business risk is unchanged

(ii) The project is funding by a mixture of debt and equity so as to leave the company's gearing unaltered

(iii) New debt is able to be issued at the same cost as the existing loan stock.

These conditions perhaps relaxed if the project is small as business risk and gearing don't change much and/or if finance is deemed to come out of the "pool" so any change in gearing is seen to be short term. Nevertheless in this case Oxfield is to undertake a "major" investment so the above three concerns must be addressed.

The size of the investment perhaps such that a public issue of shares would be required for equity finance. These new shareholders may perhaps have a different risk perception of the company and project than existing shareholders so the company Ke would change again invalidating the existing WACC.


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