The WACC is a weighted average of the costs of debt, preferred stock, and common equity. Would the WACC be different if the equity for the coming year came solely in the form of retained earnings versus some equity from the sale of new common stock? Would the calculated WACC depend in any way on the size of the capital budget? How might dividend policy affect the WACC? Assume that the risk-free rate increases. What impact would this have on the cost of debt? What impact would it have on the cost of equity?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Explain the following:
- The WACC is a weighted average of the costs of debt, preferred stock, and common equity.
Would the WACC be different if the equity for the coming year came solely in the form
ofretained earnings versus some equity from the sale of new common stock? Would the
calculated WACC depend in any way on the size of the capital budget? How might
dividend policy affect the WACC? - Assume that the risk-free rate increases. What impact would this have on the cost of debt?
What impact would it have on thecost of equity ?
Note: Explain Shortly And To the Point Answer
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