Question

What does it mean if a company WACC doesn't drop much when you drop the risk free rate by 5%?

Initial WACC was - 4.85%

then dropped the risk free rate from 0.12% to 0.07%

meaning I also dropped the cost of debt from 0.12% to 0.07% (is this correct)?

Which gave me a new WACC of 4.77% which doesn't seem like a big change to me?

Answer 1

~ The treatment done by you is Incorrect. The reason is that a fluctuation in the riskfree rate impacts the cost of equity. It does not impact the cost of debt.

~ The cost of equity is calculated as : Riskfree rate + beta * (Marketket return - Riskfree rate)

~ Now, a drop of 5% in the riskfree rate will does not lead to a direct drop of 5% in the WACC . We will have to adjust the Cost of Equity now which will now be reduced (not exactly 5%). And at last, new WACC shall be computed with same cost of debt and new cost of equity.