Question

Discuss whether and how WACC might be used to value an entire business.

Answer 1

Weighted average cost of capital is the cost of capital associated with the business which is derived after ascertainment of of weights assignment to different types of financing and cost of those financing methods.

weighted average cost of capital is calculated after ascertainment of cost of debt and cost of equity along with weight of debt and weight of equity so it will also be adjusting for the taxation because interest which are payable on debt capital are tax deductible in nature.

weighted average cost of capital can be used to value and entire business because it can be used to discount the cash flows associated with company at various different juncture and various different projects so it will be discounting all the cash flows at the net present value to arrive the total value of the firm.

Dividend discounting methods using a constant growth rate or without any growth rate always use weighted average cost of capital as required rate of return in order to find out the entire value of business by discounting the future dividend associated with the business and it is done for finding the intrinsic value of share.

Weighted average cost of capital can also be used as a hurdle rate for various types of investment which are made by the business so it will always be compared with the return on investment in order to arrive at a decision making whether to invest into the company or not so it is used to value the business.

weighted average cost of capital is also used as minimum expected rate of return and investor wants to make out of the company so it will always be used too find the value of overall return from investment and hence it is an adequate method of valuation of the entire business.

so it can be summarised that weighted average cost of capital can be used to value the business of a company through above listed features.