FIN 370 Week 4 DQ 2

FIN 370 Week 4 DQ 2 - of capital, which drives valuation of...

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Discussion Question(s) #2 Please reply to this thread by or before Friday, day 4 with your answers! What is meant by WACC? What are some components of WACC? Why is WACC a more appropriate discount rate when doing capital budgeting? What is the effect on WACC when an organization raises long-term capital? What is meant by WACC? A company’s assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances. http://investopedia.com/terms/w/wacc.asp What are some components of WACC? Why is WACC a more appropriate discount rate when doing capital budgeting? All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. WACC is an important measure of a companies combined cost
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Unformatted text preview: of capital, which drives valuation of the interest rate paid to shareholders. When doing capital budgeting, knowing the total WACC for a targeted capital structure allows the organization to adjust its various WACC components (basically debt and equity) to maximize the tax benefits (of interest on debt) without overburdening its cash flow and total debt loads. What is the effect on WACC when an organization raises long-term capital? When an organization needs to raise long-term capital, it will result in two types of increases in WACC. The first increase is a basic interest rate addition to correspond with the increase in debt or equity. The second increase is a risk adjustment to the rate. Further, because the overall capitalization increases, the risk adjustment will be higher (due to the higher risks inherent in higher capital). The net impact on WACC is an increase that is slightly higher than the proportional increase in total capital....
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