Question

How does a recession affect WACC and why?

Answer 1

At the times of the recession, the cost of capital of the firm will increase because there would be credits squeeze & the cost of capital would be increasing because the lenders would not be agreeing to issue the debt at lower rates and they will be charging an additional rate for their debt because they are sceptical about the recovery of debt and they will also want collateral for their debt.

But it can be e thought from another angle as well when at the time of recession, the tax rate are lowered by the Federal Reserve, and the interest rates are also lowered by the Federal Reserve, it means that the payments which are due to the company, will decrease because interest are a substantial portion of the overall cost of debt and the rate of interest decreasing means overall cost of debt decreasing, leading to overall weighted average cost of capital decreasing.

it can be thought from another angle because at the time of the recession, the corporate taxes are also lower, so the interest rate tax benefits would be lower and it can also increase the weighted average cost of capital because it will increase cost of debt.