Question

Identify and explain the significance of four factors that a firm cannot control that may have an impact on its WACC.

Answer 1

Four factors that a firm cannot control are:

Interest Rates: Interest rates influence a corporation's capital structure by affecting the cost of debt capital. The connection between interest rates and the cost of debt financing is easy to see. When you borrow money, you have to pay interest to the lender. That's the price you pay for using the lender's money. When interest rates are rising, you'll pay more in interest, and your cost of capital rises. When interest rates fall, you'll pay less for debt financing.

Tax Rate: Tax Rate whic are set by the governments have an important effect on the cost of capital. They are used when we calculate after tax cost of debt. As tax rates increase, the cost of debt decreases, decreasing the cost of capital.

Market Risk Premium: Investors aversion to determine the market risk premium. Individual firms have no control over market risk premium, which affects the cost of equity and thus the cost of capital. A higher premium will increase the cost of equity and this the cost of capital

Credit Crisis: When credit crisis happens, it is impossible to raise capital in reasonable rates. These are rare events. The most recent one is the 2008-09 financial crisis.