Question

Please rate the following statement as "TRUE" of "FALSE":

"The key underlying assumption of the WACC is that the CAPM holds. Thus, the WACC model implicitly assumes that: (1) all risk that matters is systematic (market driven) in nature (2) and all assets have zero alphas, and thus no opportunity for superior risk-adjusted returns. Yet, we still apply the WACC to value a firm's fair stock price, which would be a nonsensical exercise to perform if we truly believed all firms are always perfectly priced and have zero alpha opportunity".

Answer 1

This statement is FALSE because the given statement has only considered the cost of equity but weighted average cost of capital will also be considering the cost of debt which is not a part of Capital Asset pricing model so Capital Asset pricing model is mostly related to calculation of the cost of equity and weighted average cost of capital will be trying to ascertain that capital and leverage advantages associated with it and it will be trying to also discount the interest tax shield so it is a more enhanced method in comparison to Capital Asset pricing model which is just providing with a risk adjusted rate of return for investment in securities.

I will NOT AGREE with this statement that weighted average cost of capital is a nonsensical exercise to perform because the given statement has not considered the benefit associated with the weighted average cost of capital which ascertain the debt capital weightage with appropriate advantage of leverage and it will also trying to ascertain the total hurdle rate rather than just the cost of equity which is the major focus of Capital Asset pricing model so I will disagree with this statement.