Under which circumstance can the WACC be used in investment appraisals

Expert Solution

Solution:
WACC: A company can raise capital from equity, debt and sometimes from preference shares and there are the different cost attached o each mode of financing. So WACC is nothing but the average return that each fund providers seek. Any organization faces business risk and financial risk and WACC incorporates both of them.
When we use WACC for investment appraisals then we discount the future cash-flow with WACC and since we are discounting it with WACC so we must make certain assumptions
The Debt and equity ratio remains the same throughout the investment and project period
The company faces same business and financial risk
If these risk changes then we have to do adjustments and use the marginal cost of capital
If further capital is raised then also average debt and equity proportions need to remain same over the period of time
Required return by the fund entity does not change with the small projects or large projects

jeff jeffy answered 2 years ago

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