Question

What are the implications for a company's WACC and Minimum Required Free Cash Flow Return on Assets if a company only uses Equity capital to finance its investment in Total Assets?

Answer 1

ANS:

Weghted Averae cost of capital (WACC) is the calculation of firm's cost of capital in which each category of capital (like equity, debt, preference etc) is being weighed proportionately.WACC represents the investor's opportunity cost that they take on account of their money.

Implications are - It serves as a discounting rate for the calculation purpose of NPV & it also evaluates the opportuinty cost. Investors uses WACC to decide whether to invest or not.

Free Cash Flows are the left over cash after the disbursement of its operating expenses & capital expenditure.It represents a cash that a company generates from its day to day operations.

Basically the minimum required retun is calculated by - Rf + Beta (Rm - Rf)

Return on assets indicated the capital intensity of the company depending upon the size & structure of industry. While Equity finance or investment is made via purchasing shares of a listed company.

So, the minimum required return on assets shall be equal to the future economic benefit derived from assets & if such assets are being financed by way of equity then it should be equal to dividend or return on equity.