generally, which is larger for a firm? thanks in advance.
WACC is a weighted average of cost of equity and after-tax cost of debt. Since after-tax cost of debt is lower than cost of equity, WACC is lower than cost of equity.
there is no compare between WACC and cost of equity. It is part of WACC !!! you may ask which large cost of debt or cost of equity . thnks
you can obviously compare cost of equity and WACC… You must not be familiar with Miller and Modigliano’s literature which is an important part of CFA curriculum. I’m assuming this is level 1 material, but level 2 explains it very well. +1 on Cityboy’s answer…WACC will always be lower because debt is cheaper and is incorporated into WACC
WACC could be equal to cost of equity if the company has 100% equity capital. However, most company has both Debt and Equity, hence I agreed that WACC is lower the cost of equity.
who you calling Wacc?
oops, yeah sorry i put the statement ‘always’ - I normally try to avoid that dreadful word… why is this question even on level 2 forum anyway?
It is possible for a company’s cost of debt to be greater than their cost of equity in certain situations and/or countries which will push WACC above cost of equity. Let’s say in Country X, the capital structure favors equity. Boom, the costs are switched. Let’s say you have a startup company who is thinking about going public. Depending on the economic environment, it might be cheaper to just do an IPO than to approach a bank for a loan. These are just off the top of my head but it is possible. Not probable, but possible. So the answer to the OP’s question should be: “Depending on the economic climate, the laws of the country in question, the development level of the firm, and a host of other factors, the answer I would give is” In the United States the cost of equity is less than WACC because the cost of debt with the tax shield brings down WACC; however, it is possible for the cost of debt to be too high and/or for the tax shield to be removed from legislation which will cause WACC to be higher than cost of equity."
^I agree. There are exceptions.
"These are just off the top of my head but it is possible. Not probable, but possible. " exactly. give me a concrete example instead of just theoretical ‘what ifs’
I just did… You said WACC will always be lower than cost of equity, then you agreed that WACC could be equal to cost of equity if there’s no debt, I just showed you that it is possible for cost of debt to be higher than cost of equity which will mean WACC will be higher than cost of equity. Do you want me to explain my examples more or something?
Insightful stuff. Are there countries that actually favor investors over lenders ?