Question

Please critically comment on the following sentence

“Weighted Average Cost of Capital (WACC) is too complicated and not useful for financial management as we should only calculate the cost of borrowing/debt since we do not have to pay our shareholders any dividends if we choose to.” 


According to a Chief Financial Officer of a listed company, she thinks that financial leverage is more effective than operating leverage in the real world as one can use financial derivatives to manage the risk accordingly. Do you agree with her?

Answer 1

I do not agree with her because her statement is completely false as cost of equity also play an important role in overall capital decision making because cost of Equity is an important factor in determination of overall cost of capital.

when it comes to using of cost of borrowing it has a high implication in the overall cost of capital but cost of equity does not mean that they are completely to be ignored because they are to be adjusted with their overall weight in order to decide with the optimum cost of capital which is to be used in the company.

when the financial manager things that financial leverage is more effective than the operating leverage in the real world as one can use financial derivatives to manage with their risk I will be not agreeing with him completely because operating leverage are also important part of risk management and they are helping the company in order to grow because operating leverage are generally associated with large cost which will be required in order to easily grow and expand if the company is able to use them and manage them properly,whereas financial leverage is associated with financial management and they can also be hedged through derivative contracts like futures and options and forward contracts so I do not agree with the financial manager.