A company’s optimal capital budget is best described as the amount of new capital required to undertake all projects with an internal rate of return greater than the: A. marginal cost of capital. D. weighted average cost of capital. Which one/why and what’s the difference?
A - Amount to generate new capital is the marginal cost of capital by definition Correct if im wrong.
that’s correct by why is it not D? What’s the difference between WACC and MCC? Where is the WACC used then?
The optimal capital budget is that amount of capital raised and invested at which the marginal cost of capital is equal to the marginal return from investing (marginal cost of capital is equal to the marginal return of investing). What is interesting is the cfa book says that the WACC is also referred to as the marginal cost of capital because it is the cost that a company incurs for additional capital.
From a level 1 perspective (at least how CFAI wants you to understand it in level 1), the WACC is the MCC. The WACC is the amount of money it will cost the company to get additional funding. Therefore, the WACC can also be thought of as the MCC. The optimal capital structure (not budget) is that capital structure with the lowest WACC (meaning that the optimal capital structure is the structure where an investor cannot further reduce his or her cost of capital.
Ah, thanks nc… yeah i know what you mean about Schweser, i picked up the book to look at the definition and saw that, so thought I’d ask here.
As a firm raises more money, the cost of each additional dollar of new capital may increase because of greater risk and higher flotation costs. The marginal cost of capital (MCC) is the cost of the last dollar of new capital raised. If a firm uses more than one type of new financing, the MCC represents a weighted average cost of the last dollar of capital raised, reflecting higher marginal costs. A firm’s weighted average cost of capital (WACC) equals its MCC until the cost of a capital component increases.
So therefore MCC can be thought of as the lowest WACC of last dollar of capital raised? Is that correct?
MCC and WACC are the total opportunity costs of investing in the project
what about this one: Metiu Metev, an analyst with Sofia Equity Researchers, has gathered the following information about Balkan Steel Mills (BSM): Current year’s operating free cash flow BGN 5 million Cost of equity capital 15% Weighted average cost of capital 12.4% Estimated long-term growth rate 6% Given this information, Metev’s best estimate of BSM’s intrinsic value (in BGN millions) would be closest to: A. 55.56 million. B. 58.89 million. C. 78.13 million. D. 82.81 million. Which one do you use Ke or WACC and why?
use WACC for that prob ! I know its so confusing…
You would use WACC here, as the numerator is Operating free cash flow. If numerator is Free cash flow to equity, you use cost of equity.
mambovipi Wrote: ------------------------------------------------------- > what about this one: > > Metiu Metev, an analyst with Sofia Equity > Researchers, has gathered the following > information about Balkan Steel Mills (BSM): > > Current year’s operating free cash flow BGN 5 > million > Cost of equity capital 15% > Weighted average cost of capital 12.4% > Estimated long-term growth rate 6% > > > Given this information, Metev’s best estimate of > BSM’s intrinsic value (in BGN millions) would be > closest to: > > A. 55.56 million. > B. 58.89 million. > C. 78.13 million. > D. 82.81 million. > > Which one do you use Ke or WACC and why? C, use WACC and the optimial refers to the marginal cost of borrowing, i remember that got me in the CFAI books, so i wont forget it