Capital Structure & WACC — Flashcards

Question

How is $W A C C$ used in project evaluation?

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Answer

It is the hurdle rate for projects with average firm risk.

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Question

What is the full weighted average cost of capital formula?

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Answer

$W A C C = [w_{d} \times r_{d} \times (1 - t)] + [w_{p} \times r_{p}] + [w_{e} \times r_{e}]$

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Question

In the $W A C C$ formula, what do the weights $w_{d}$ , $w_{p}$ , and $w_{e}$ represent?

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Answer

Target or market-value proportions of debt, preferred, and equity.

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Question

Why is the cost of debt in $W A C C$ multiplied by $(1 - t)$ ?

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Answer

Interest is tax-deductible, so debt cost is after tax.

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Question

How is $W A C C$ used in project evaluation?

Tap to flip

Answer

It is the hurdle rate for projects with average firm risk.

Tap to flip back

Question

What is the full weighted average cost of capital formula?

Tap to flip

Answer

$W A C C = [w_{d} \times r_{d} \times (1 - t)] + [w_{p} \times r_{p}] + [w_{e} \times r_{e}]$

Tap to flip back

Question

In the $W A C C$ formula, what do the weights $w_{d}$ , $w_{p}$ , and $w_{e}$ represent?

Tap to flip

Answer

Target or market-value proportions of debt, preferred, and equity.

Tap to flip back

Question

Why is the cost of debt in $W A C C$ multiplied by $(1 - t)$ ?

Tap to flip

Answer

Interest is tax-deductible, so debt cost is after tax.

Tap to flip back