Question
In: Finance
How does WACC come into play in financing decisions such as the optimum capital structure?
How does WACC come into play in financing decisions such as the optimum capital structure?
Solutions
Expert Solution
The capital structure of a company is comprised of optimum level of debt and equity which help maximising the Overall value of company. WACC affects the value of the firm as it is the weighted cost associated with financing of different types of capital financing.
The optimum mix of debt as well equity is focused on maximization of the overall value of the firm while minimising the Overall WACC.
WACC has an inverse relationship with overall value of the firm. When the value of WACC goes up, the value of the firm comes down as it is discounted with higher rate. When the value of WACC goes down, the relative value of the company goes up.
WACC is also used a hurdle rate by many companies to be used in investment decision . A project has to atleast return the WACC to get approved and accepted.It also servs as a discount rate for calculating the NPV of different projects .It is considered to be a representative of opportunity cost so overall it has a very high significance while making Investment decision by various companies .
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