29 Lecture - WACC (Weighted Average Cost of Capital)

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29 Lecture

MGT201

Midterm & Final Term Short Notes

WACC (Weighted Average Cost of Capital)

WACC (Weighted Average Cost of Capital) is the average cost of a company's debt and equity financing, weighted by their respective proportions. It represents the minimum return that a company must earn on its investments to satisfy investors' ex


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  1. What does WACC stand for? a) Weighted Annual Cost of Capital b) Weighted Average Cost of Capital c) Weighted Asset Cost of Capital d) Weighted Accumulated Cost of Capital Answer: b) Weighted Average Cost of Capital

  2. What does WACC represent? a) The maximum return that a company can earn on its investments b) The minimum return that a company must earn on its investments c) The average return that a company earns on its investments d) The weighted return that a company earns on its investments Answer: b) The minimum return that a company must earn on its investments

  3. Which components of a company's capital structure are included in the WACC calculation? a) Equity and preferred stock b) Debt and equity c) Debt and preferred stock d) Debt, equity, and preferred stock Answer: b) Debt and equity

  4. How is the cost of debt calculated in the WACC formula? a) Interest rate minus tax rate b) Interest rate plus tax rate c) Interest rate divided by tax rate d) Tax rate divided by interest rate Answer: a) Interest rate minus tax rate

  5. How is the cost of equity calculated in the WACC formula? a) Dividend yield plus capital gains yield b) Dividend yield minus capital gains yield c) Dividend yield times capital gains yield d) Dividend yield divided by capital gains yield Answer: a) Dividend yield plus capital gains yield

  6. How does an increase in the cost of debt affect WACC? a) It increases WACC b) It decreases WACC c) It has no effect on WACC d) It depends on the proportion of debt in the capital structure Answer: a) It increases WACC

  7. How does an increase in the cost of equity affect WACC? a) It increases WACC b) It decreases WACC c) It has no effect on WACC d) It depends on the proportion of equity in the capital structure Answer: a) It increases WACC

  8. What is the purpose of calculating WACC? a) To determine the maximum return that a company can earn on its investments b) To determine the minimum return that a company must earn on its investments c) To determine the average return that a company earns on its investments d) To determine the weighted return that a company earns on its investments Answer: b) To determine the minimum return that a company must earn on its investments

  9. How is WACC used in investment analysis? a) As a hurdle rate for investment projects b) As a target return for investment projects c) As a benchmark for investment projects d) As a discount rate for investment projects Answer: d) As a discount rate for investment projects

  10. What is the relationship between WACC and a company's market value? a) WACC is directly proportional to the company's market value b) WACC is inversely proportional to the company's market value c) WACC has no relationship with the company's market value d) It depends on other factors besides WACC Answer: b) WACC is inversely proportional to the company's market value



Subjective Short Notes
Midterm & Finalterm Prepration
Past papers included

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  1. What is the formula for calculating WACC? Answer: WACC = (E/V x Re) + (D/V x Rd x (1 - Tc)), where E is equity, V is the total value of the company, Re is the cost of equity, D is debt, Rd is the cost of debt, and Tc is the corporate tax rate.

  2. What is the significance of WACC in capital budgeting decisions? Answer: WACC is used as a discount rate to evaluate investment projects. It represents the minimum rate of return that a company must earn on its investments to maintain its market value.

  3. What factors affect the cost of debt? Answer: The factors that affect the cost of debt include the creditworthiness of the borrower, the prevailing interest rates, the maturity period of the debt, and the collateral or security offered by the borrower.

  4. What factors affect the cost of equity? Answer: The factors that affect the cost of equity include the risk-free rate of return, the equity risk premium, the company's beta, and the market risk premium.

  5. What is the impact of a high WACC on a company's valuation? Answer: A high WACC indicates that the company has a high cost of capital, which can negatively impact the company's valuation, as it reduces the net present value of future cash flows.

  6. What is the relationship between WACC and the capital structure of a company? Answer: WACC is affected by the capital structure of a company, as it is calculated based on the weights assigned to debt and equity in the company's capital structure.

  7. What is the impact of a change in the corporate tax rate on WACC? Answer: A change in the corporate tax rate can impact WACC, as it affects the after-tax cost of debt, which is a component of WACC.

  8. What is the impact of a high debt-to-equity ratio on WACC? Answer: A high debt-to-equity ratio increases the weight of debt in the capital structure, which increases the cost of capital and thus increases WACC.

  9. What is the impact of a high cost of equity on WACC? Answer: A high cost of equity increases the overall cost of capital, which increases WACC.

  10. What is the impact of a change in interest rates on WACC? Answer: A change in interest rates can impact the cost of debt, which is a component of WACC, and thus can impact WACC.

WACC (Weighted Average Cost of Capital) is a financial metric that represents the average cost of a company's capital. It is the minimum return a company needs to earn on its existing assets to satisfy its investors' expectations. WACC takes into account the cost of equity and debt, as well as the proportion of each in the company's capital structure. WACC is calculated by multiplying the cost of each component of capital by its respective weight and then summing the results. The cost of equity is calculated using the Capital Asset Pricing Model (CAPM), while the cost of debt is calculated by taking into account the interest rate on the company's outstanding debt. The weights assigned to each component of capital are determined based on the company's capital structure. The proportion of debt and equity in the capital structure can vary depending on the company's financial strategy, market conditions, and industry norms. WACC is an essential tool for evaluating investment opportunities and making capital budgeting decisions. The WACC is used as a discount rate to evaluate investment projects, and projects with a rate of return higher than the WACC are considered acceptable. A high WACC indicates that a company has a higher cost of capital, which can negatively impact the company's valuation. Conversely, a low WACC implies a lower cost of capital, which can improve the company's valuation. There are several factors that can impact a company's WACC, including changes in interest rates, changes in the corporate tax rate, changes in the company's capital structure, and changes in the cost of debt or equity. As such, it is important for companies to regularly monitor and analyze their WACC to ensure that it accurately reflects their financial position and market conditions. In conclusion, WACC is an essential financial metric that provides insight into a company's cost of capital. By understanding their WACC, companies can make informed decisions regarding their investment opportunities and capital structure.

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