Asked by Ariyon Powell on Jun 24, 2024
Verified
The WACC is used in evaluating newly proposed capital budgeting projects. It should therefore be calculated using capital component costs and a capital structure:
A) based on the capital on the firm's books because that's the capital it already has and will use to support new projects.
B) based on conditions the firm will encounter when raising new capital in the next year because that's the capital it will use to support new projects.
C) based on existing capital on the books because both old and new projects have to be supported.
D) based on existing equity but new debt amounts and costs.
Capital Budgeting
The process a business undergoes to evaluate potential major projects or investments, analyzing the expected cash flows to determine whether they meet a set investment criteria.
Capital Structure
The composition of a company's funding through a mix of debt, equity, and other financing sources to finance its operations and growth.
WACC
Weighted Average Cost of Capital, a calculation of a firm's cost of capital in which each category of capital is proportionately weighted.
- Describe the considerations in calculating the Weighted Average Cost of Capital (WACC) for new capital budgeting projects.
Verified Answer
MJ
Marian Jordan-JonesJun 24, 2024
Final Answer :
B
Explanation :
The WACC should be calculated based on the conditions the firm will encounter when raising new capital in the next year because that's the capital it will use to support new projects. The WACC is a forward-looking measure that takes into account the cost of new capital that the firm will need to raise to support future projects, not just the capital that is already on the firm's books. By using the current conditions, the WACC will be more accurate and relevant for making investment decisions.
Learning Objectives
- Describe the considerations in calculating the Weighted Average Cost of Capital (WACC) for new capital budgeting projects.