What does WACC tell us about a company?
A high weighted average cost of capital, or WACC, is typically a signal of the higher risk associated with a firm’s operations.
Investors tend to require an additional return to neutralize the additional risk.
A company’s WACC can be used to estimate the expected costs for all of its financing..
What is WACC and why is it important?
The weighted average cost of capital (WACC) is an important financial precept that is widely used in financial circles to test whether a return on investment can exceed or meet an asset, project, or company’s cost of invested capital (equity + debt).
Is a higher or lower WACC better?
It is essential to note that the lower the WACC, the higher the market value of the company – as you can see from the following simple example; when the WACC is 15%, the market value of the company is 667; and when the WACC falls to 10%, the market value of the company increases to 1,000.
Why is a lower WACC better?
As a general rule, lower WACC levels suggests that a company is in a prime position to more cheaply finance projects, either through the sale of stocks or issuing bonds on their debt.
What are the biggest disadvantages of using WACC?
Moreover, the advantages of using such a WACC are its simplicity, easiness, and enabling prompt decision making. The disadvantages are its limited scope of application and its rigid assumptions coming in the way of evaluation of new projects.
Why do we use the overall cost of capital for investment decisions?
The cost of capital aids businesses and investors in evaluating all investment opportunities. It does so by turning future cash flows into present value by keeping it discounted. The cost of capital can also aid in making key company budget calls that use company financial sources as capital.