Wacc Essay

269 WordsFeb 24, 20152 Pages
why is it so important to estimate wacc and firm’s cost? The weighted average cost of capital (WACC) is the rate at which the firm is able to raise investment for future or ongoing projects. The WACC is an average cost because it is a weighted average of the firm's component costs of capital. This includes the cost of debt to debt holders and cost of equity (including preferred stock and common stocks) to shareholders. WACC is calculated considering the relative weights of each component of the capital structure- debt and equity, and is used to see if the investment is worth taking. Following are the reasons to why it is important to estimate a firm’s cost:- a. Capital Budgeting Decision: It is important to estimate a firm’s cost of capital to decide Capital Budgeting Decision. Cost of capital is used to decide whether an investment proposal should be undertaken or not. A wrong estimation of WACC would lead to selection of a wrong investment or rejecting a good investment proposal. b. Method of financing decision: The WACC can be observed constantly to see the marketchanges in interest rate on load and dividend rates on stocks to make a better choice of thesource of financing when the firm needs financing. The idea here is to minimize the cost of capital based on market changes. c. Firms Performance: This can also be used as a measure to evaluate the performance of the firm based on comparing the returns that it is getting from a selected project and the cost it is incurring in raising the finance for this

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