Question

Why is the WACC used in capital budgeting?

Explain some of the factors that can affect the cost of capital and describe whether or not it is something that a company can control.

Answer 1

The Weighted Average Cost of Capital or WACC is used in the capital budgeting to ascertain the interest rate that the organization is paying when they are using multiple means of financing say, debt, equity- general or preference shares.

Factors affecting cost orof capital:

1. Fundamental Factors: It includes Risk(higher the risk, higher the return and vice versa), Inflation (the investment generates the real income if the weighted average cost of capital exceeds the inflation and if the inflation is higher than the Cost of capital, there is no real return in such scenario)

2. Economic Factors: It includes federal Reserve policy, country and exchange rate risk.