Weaknesses of wacc as discounting rate, Finance Basics

Weaknesses of WACC as Discounting Rate

WACC/Overall cost of capital has the following problems like a discounting rate as:

  1.  It can simply be used as a discounting rate assuming such the risk of the project is equal to the business risk of the firm. A percentage premium will be added to WACC to verify the suitable discounting rate If the project has higher risk.
  2.  It suppose which capital structure is optimal that is not achievable in real world.
  3.  It is based on market values of capital that keep on changing thus WACC will transform over time however is assumed to remain constant during the economic life of the project.
  4.  It is based on past information especially whenever determining the cost of each component as like in determining the cost of equity (Ke) the past year's DPS is used whereas from the past stream of dividends the growth rate is estimated.

Note

When using market values to verify the weight/proportion in WACC, the cost of retained earnings is left out as it is already involved or reflected in the MPS and hence the market value of equity. Retained earnings are an internal origin of finance hence; whenever they are high there is low gearing, lower financial risk and hence highest MPS.

Posted Date: 1/30/2013 4:39:15 AM | Location : United States







Related Discussions:- Weaknesses of wacc as discounting rate, Assignment Help, Ask Question on Weaknesses of wacc as discounting rate, Get Answer, Expert's Help, Weaknesses of wacc as discounting rate Discussions

Write discussion on Weaknesses of wacc as discounting rate
Your posts are moderated
Related Questions
John has just inherited $50,000 from his Uncle Ted. John is currently studying his Bachelor of Accounting degree at CQUniversity part-time and has three (3) years of study remainin

This case has been framed in order to test the skills in evaluating a credit request and reaching a correct decision

What are the Features of Stock Exchange The key features of stock exchange are as below: (1) Organised Market: Stock Exchange is an organized market. Each stock exchang

Suppose an entrepreneur owns a firm that has a production technology that generates the following revenue: R(e) = e 2 +100e where revenue depends on his effort level e. The monetar

Development of Lease Finance in Middle Asia Reasons Why Lease Finance Is Not Well Developed In Middle Asia 1. Lease charges are generally prohibitive that is the cost

ROA - Return on Assets The Average of the industry ROA was 10.02% for 2004, 6.81% for 2005, and 7.32% for 2006. The chart showed that Lenovo had a little bit higher ROA th

Underwriting - Stock Market 1. This is the supposition of risk relating unsubscribed shares 2. When new shares are issued, they might be beneath -written or unsubscribed. A

Basic EOQ Model The basic inventory decision model is Economic Order Quantity or called EOQ model. This model is specified via the following equation as: Whereas:Q is

A compnay can arrange for a secured loan amounting to 150,000,000 for one year at an interest rate of 18% per annum based on the initial balance of the loan. The lender also imposs

Problem: Cash Flow Analysis For the attached Gantt chart, the following information is available: Invoices are sent at the end of each month. Mark up is 20% on each invoi