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
Suppose the ABC Corporation is currently all-equity financed and would like to increase its value by issuing debt. The firm has annual earnings before interest and taxes of $7,0

Price Earnings Ratio Valuation P/E ratio is traditionally employed for valuation of shares however it is an important ratio in the valuation of business. The P/E ratio is the

Your client, a man, is currently 35 years old and he wants to retire when he is 65 years old (exactly 30 years from now). He would like his retirement income to be equivalent to

Analysis of the bond issue (a) Show that the price of the bond is equal to that of a portfolio which contains i) a long position in an option-free but otherwise identical co

Compute the Payback Period - Example Cedes restriction has the following details of two (2) of the future production plans. Just one of these machines will be purchased and su

What does it mean to say that individuals as a group are net suppliers of funds for financial institutions? What do you think the consequences might be in financial markets if indi

Louis Futon Co. is currently an all-equity firm. The current market value of the company is $80 million. The corporate tax rate is 35%. What is the new value of the company if Loui

What role do primary financial markets play in our economy? What role do secondary markets fill? Describe the relationship that exists between financial institutions and financial

2.Calculating Project NPV-The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporation tax rate i

Cash and Bonus Issue - Dividend For a firm to pay cash dividends, it should contain adequate liquid funds.Though, under conditions of liquidity and financial constraints, a fi