I keep getting a recurring question in qbank and don’t really understand… If you have a project with a higher risk, wouldn’t you still just use the normal wacc as it is also the marginal cost of capital for the firm? Regardless of any adverse selection consequences (accepting overly risky projects, rejecting lower risk projects)? Thanks in advance.
who you calling wack Muffin?
WACC is the weighted average. If you have riskier project (riskier than average), you will want to use higher than average cost of capital to evaluate.
revenant Wrote: ------------------------------------------------------- > WACC is the weighted average. If you have riskier > project (riskier than average), you will want to > use higher than average cost of capital to > evaluate. I know bro, I_Passed_Level_1
think of it this way… WACC = risk level More risk = more WACC
But do you gear down for lower risk projects?
I dont think so. I think WACC automatically “gears up/down” depending on how risky a project is. Remember, WACC is partly influenced by what risk the market percieves you to be at.
muffin09 Wrote: ------------------------------------------------------- > But do you gear down for lower risk projects? why would I gear down, it depends what the cost of equity or cost of debt are at the time, in bad times and in complex, risky environments, they are going to be adjusted higher. you cant discount cash flows at the rate of t-bill jabroni
I_P_L_1 Did you see the thread on WSO where a kid was asked if WACC increased or decreased in 2008 and the kid said increased and the MD interviewing him said he was wrong. It ended up being a pretty good discussion, I still think on a whole WACC went up in 2008. Its a nice subject to ponder though.
huh? it varies by company bro.
I_Passed_Level_1 Wrote: ------------------------------------------------------- > huh? it varies by company bro. Also depends the market and the overall economic stability. Remember two main components of WACC - Company’s Beta and yield
pupdawg82 Wrote: ------------------------------------------------------- > I_Passed_Level_1 Wrote: > -------------------------------------------------- > ----- > > huh? it varies by company bro. > > > Also depends the market and the overall economic > stability. Remember two main components of WACC - > Company’s Beta and yield no sh1t bro, but it starts with a bottom-up approach.
It was supposed to be on average. Not precise but general movement of CoC
WACC appears in L2 curriculum as well, where it is much better explained. Assume you have a new project, whose risk is not known…then i’d use the WACC. But If I know for sure that this project is riskier…lets say investing in Distressed asset backed ABS, would i not use a higher rate of discount? It seems pretty natural to me to use higher WACC. So the qn is, What is the use of WACC if you keep moving it up or down? The answer, I think is - WACC is a good tool to value a company’s cashflow while finding out its value. In other words if you want to find out the value of a company using the FCFF ( DCF method) use WACC.
I think it’s one of weakness of using one WACC for all projects a firm takes. The use of constant WACC sometimes rejects a good project with lower risk and accepts a bad project with higher risk. For example, let’s say the cost of capital for Starbucks is 10%. If Starbucks develops a new cheeseburger that will be competing with McDonalds. Then, yes, it should be much riskier than coming out with new flavor latte, so should have used higher cost of capital than 10%. So, there is a chance that accepts a project with higher risk and reject a project with lower risk. However, I don’t think we need to considering using different WACC for riskier project when calculating NPV in level 1. Hope it makes sense.