Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be...

Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be expected to affect each component of the weighted average cost of capital (WACC). What mistakes are commonly made when estimating the WACC, and how do these mistakes arise? Please list and describe four to five.

Expert Solution

When the Federal Reserve will be increasing the interest rate, it would mean that cost of debt will go up because increase in interest rate would be meaning that increase on the already issued loan coupons go up because interest rates will be going up and interest payments will be increasing so that cost of debt will be increasing.

Increase of interest rates by Federal Reserve on cost of equity will not be much because it will be not impacting the equity as equity capital have already been issued with flotation cost and there is no inclusion of interest in it.

Weighted Average cost of capital of the company will be increasing due to the increase in the interest rates by the Federal Reserve.

Mistakes which are made during estimation of weighted average cost of capital are as follows-

A. Estimating wrong inflation rate-it could be corrected through proper estimation strategies and demand and supply pattern into the economy along with estimation of economic cycles

B. Estimation of wrong growth rate and discounting rate- It can be only done through proper analysis and application of various forecasting approaches.

C. Macro risk regarding monetary policies are not discounted properly.it should be proactively determined through past trends and prediction of economic cycles.

D. Similar weighted average cost of capital is adopted for all the project but it has to be specific and it should be allocated specifically according to the risk exposure of different projects

jeff jeffy answered 2 years ago

Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be...

Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be expected to affect each component of the weighted average cost of capital (WACC). What mistakes are commonly made when estimating the WACC, and how do these mistakes arise?

Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be...

Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be expected to affect each component of the weighted average cost of capital (WACC). What mistakes are commonly made when estimating the WACC, and how do these mistakes arise?

Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be...

Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be expected to affect each component of the weighted average cost of capital (WACC). What mistakes are commonly made when estimating the WACC, and how do these mistakes arise?

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Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be...

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