Capital budgeting involves decisions about whether or not to invest in fixed assets, and has a great influence on the future performance and value of companies. Discounted cash flow analysis is used in capital budgeting, and a key element of this procedure is the discount rate used in the analysis. Capital must be raised to finance fixed assets, and this capital comes from different types of debt, preferred stock, and common stock. Each of these components of capital has a cost, and these types of expenses, along with the proportions of each, are used to calculate the company's weighted average cost of capital, WACC (WACC).

 

1) What is the Weighted Average Cost of Capital (WACC) and how is it calculated? Present and interpret the formula seen in the weekly talk. 

2) What is the main benefit of debt financing? How does an over-indebtedness affect corporate value and can it nullify the benefit derived from the tax shield? 

3) What are the benefits, costs and risks of an aggressive financing strategy and a conservative financing strategy? 

4) How is the optimal WACC (WACC) determined? Explain your answer. 

5) Calculate the WACC of the Cacao del Pacifico company based on the following data and say what possible aspects could improve this opportunity cost or cost of capital: 

Passives / Actives: 55% Net Worth / Assets: 45% Average cost of liabilities: 9.57% Corporate tax rate: 40% 5-year US Treasury risk-free rate: 2.88% Market rates: 10.5% Beta of the Cacao del Pacfico share: 0.80.

Answer rating: 100% (QA)

WACC is the cost of capital that a company pays to raise funds from various sources such as debt equity and preferred shares It is calculated as the w... View the full answer