WACC vs. Required Return on Equity

CFA Level II Equities
#1

I’m sure this questions has been asked so many times, but when do we use WACC and when use Required Return on Equity? I’m asking the questions under the context of Equity Valuation.

I assume WACC is used to valuate the entire company (debt + equity), and Required Return on Equity for company’s equities only. But say when we’re calculating H model, PVGO, residual income etc., this could be a bit confusing…

Thanks.

#2

If you’re using the H model for dividends or FCFF, use WACC; if you’re using it for dividends or FCFE, use rCE. (I think it appears only in the DDM reading, so that’s a help.)

PVGO applies to the firm: use WACC.

Residual income applies to equity: use rCE.

#3

H model on dividends is WACC? I thought all DDMs use the cost of equity.

#4

Good catch. My mistake. I’ve corrected it.

#5

Cool, thanks for clarifying Bill.

#6

Thanks a lot for the clarifications!

When you say PVGO, I assume you’re using the formula of P = E1/r +PVGO? Why we use WACC not rCE here?

#7

I have come across a Schweser mock exam question today where they are using the required rate of return on equity.

This surely is wrong?

#8

We have to use required return of equity when calculating PVGO. We use the stock price to find it so it’s only equity.